COM/JB1/jt2 ALTERNATE DRAFT Agenda ID #6360
Ratesetting
Decision Alternate Proposed Decision of Commissioner Bohn
(Mailed 1/29/2007)
BEFORE THE PUBLIC UTILITIES COMMISSION OF THE STATE OF CALIFORNIA
In the Matter of the Application of SAN GABRIEL VALLEY WATER COMPANY (U337W) for Authority to Increase Rates Charged for Water Service in its Fontana Water Company Division by $5,662,900 or 13.1% in July 2006; $3,072,500 or 6.3% in July 2007; and by $2,196,000 or 4.2% in July 2008. |
Application 05-08-021 (Filed August 5, 2005) |
Order Instituting Investigation on the Commission's Own Motion into the Rates, Operations, Practices, Service, and Facilities of San Gabriel Valley Water Company (Utilities 337 W). |
Investigation 06-03-001 (Filed March 2, 2006) |
(See Appendix F for List of Appearances.)
DECISION REDUCING TEST YEAR RATES
AND IMPOSING A PENALTY
Table of Contents
Title Page
DECISION REDUCING TEST YEAR RATES
AND IMPOSING A PENALTY 22
II. Background and Procedural History 33
III. Water Sales and Operating Revenues 44
V. Annual Use by Customer Class 44
A. Average Use per Customer 44
B. Sales to Cemex and California Steel Industries 55
C. Miscellaneous and Construction Revenues 66
VI. Operating and Administrative Expenses 77
2. Materials and Supplies Expense 1111
3. Transportation Expense 1111
5. Outside Services Expense - Other than Legal Expenses 1111
6. Outside Services - Legal Expenses 1212
a) Non-Perchlorate- Related Legal Expenses 1212
b) Perchlorate-related Legal Expenses 1414
7. Utilities and Rents Expense 1414
c) Employee Step Increases 1919
9. Employee Pensions and Benefits 1919
a) Vacation, Holidays and Sick Leave 1919
c) Health and Dental Insurance 2020
a) Business Property and Umbrella Liability Insurance 2020
b) Worker's Compensation Insurance 2121
VII. General Office Allocation 2323
IX. Components of Rate Base 2626
A. Current Water Supply System 2626
1. Sandhill Surface Water Treatment Plant 3434
a) History and Description of the Sandhill Project 3535
b) Evaluation of Need and Cost Effectiveness 3737
3. Wellhead Treatment Facilities 4141
7. New Office and Operations Center 4545
a) Purchase of Land from Affiliate 4545
C. Contributions and Advances 5151
B. Effective Cost of Long-Term Debt 5555
XI. Revenue Recovery Issues 5757
A. Advice Letter Treatment 5757
C. Net-to-Gross Multiplier 6161
D. Calculation of Escalation Year Rates 6161
B. Monthly Service Charges 6767
C. California Alternative Rates for Water (CARW) 6868
XIII. Water Division Audit Report 6868
1. Application of Sections 789-790 7070
2. Applicability of Gain on Sale
Rulemaking D.06-05-041 in R.04-09-003 7272
3. Sale to Private Parties 7474
4. Condemnations and Sales Under Threat of Condemnation 7575
5. Compensation for Service Duplication Claims 7575
6. Proceeds from Contamination Settlement 7777
1. Sales to Private Parties 8383
3. Proceeds of Service Duplication 8484
C. Accounting Classifications 8585
D. Allocation of Proceeds 9090
F. Los Angeles County Division 9898
Appendices A - F
I. Summary
San Gabriel Valley Water Company (San Gabriel) Fontana Division is authorized and ordered:
1. For Test Year (TY) 2006-2007, to reduce rates by $1,650,000 (Appendix A, p. 1);
2. To reduce rate base as of July 17, 2004 by $1,570,421 (Appendix E, p. 2);
3. To refund to ratepayers overcharges since July 17, 2004 in the amount of $719,100 as of December 31, 2006 (Appendix E, p. 1);
4. To pay a fine of $60,000 for affiliate transaction violations.
In Decision (D.) 04-07-034, San Gabriel was authorized to increase rates subject to refund depending on our decision in its next general rate case (GRC) (Application (A.) 05-08-021) regarding the allocation between ratepayers and shareholders of the gains from sales of property, condemnation awards, contamination awards, and inverse condemnation awards. The order in D.04-07-034 was reaffirmed in our Order Instituting Investigation (OII) 06-03-001 and confirmed on rehearing in D.06-06-036. This case finds that San Gabriel misapplied Public Utilities Code Section 790 with respect to the proceeds it received related to compensation for contamination and as a consequence appropriated $1,570,421 of money which should have been allocated to ratepayers. To rectify this misappropriation we have reduced rate base by $1,570,421 relating back to D.04-07-034. Rates were recomputed from July 17, 2004 resulting in a refund of $719,100.
II. Background and Procedural History
San Gabriel is a Class A water utility providing public utility water service to approximately 88,000 customers in Los Angeles and San Bernardino Counties. The company's Fontana Water Company Division (Fontana Division) serves approximately 43,000 customers in a service area that includes most of the City of Fontana, portions of the cities of Rancho Cucamonga and Rialto, and adjacent unincorporated areas of western San Bernardino County. The region is characterized by population growth and significant water quality problems.
San Gabriel's last GRC application for the Fontana Division, A.02-11-044, resulted in D.04-07-034, which increased rates effective July 17, 2004. Those rates were set, subject to refund, pending further review and consideration of the appropriate ratemaking treatment of the proceeds of certain sales and involuntary conversions of Fontana Division properties that was considered but not finally resolved in the course of that proceeding. D.04-07-034 directed the Water Division to conduct an audit of those proceeds and directed San Gabriel to make a further showing with respect to them in its next GRC. In August 2005, the Commission responded to applications for rehearing of D.04-07-034 by issuing D.05-08-041, granting rehearing of D.04-07-034 for certain issues, and specifying that currently authorized rates for the Fontana Division are subject to refund. An OII was issued March 2, 2006. The order in D.04-07-034 was affirmed in D.06-06-036.
San Gabriel tendered on June 6, 2005, its proposed application for a general rate increase for TYs 2006-2007 and escalation years 2007-2008 and 2008-2009. After review by the Division of Ratepayers Advocates (DRA), San Gabriel corrected deficiencies and with DRA's approval filed its GRC application (A.05-08-021) on August 5, 2005, seeking an increase in rates of $5.7 million (13.1%) for TY 2006-2007, $3.1 million (6.3%) for escalation year 2007-2008, and $2.2 million (4.2%) for escalation year 2008-2009. Protests were filed by the City of Fontana (City), the Fontana Unified School District (District), and DRA. On September 19, 2005, Water Division issued its audit report on the results of its examination of San Gabriel's property sales and condemnations.
Public participation hearings were held on November 17, 2005. Beginning on January 9, 2006, seven days of evidentiary hearings were held. The record was submitted on April 14, 2006, after receipt of late-filed exhibits and opening and reply briefs.
III. Water Sales and Operating Revenues
The Company's forecast of active service connections, sales, and operating revenues by customer class for year 2005, TY 2006-2007, and the two escalation years were uncontested for the most part. DRA accepted San Gabriel's estimates of annual use by every customer class except for large industrial customers.
IV. Service Connections
Recent and anticipated growth in the Fontana Division consists mainly of single-family residences in the northern portion of the service area, with only nominal increases in other customer classes. San Gabriel's forecast of growth in service connections was determined by adding the average growth per customer class over the past five years to the previous year's total. San Gabriel's growth forecast of 1,350 service connections was accepted by DRA.
V. Annual Use by Customer Class
San Gabriel forecasts sales on a weather-normalized basis for most customer classes by applying the New Committee Method to recorded monthly sales over the last ten years. This forecast method was accepted by DRA. The actual average use per residential customer is 322.4 ccf/conn./yr.
The only real disagreement over customer sales concerned San Gabriel's estimates of sales to two large customers in the large industrial class - California Steel Industries (CSI) and Cemex. A San Gabriel witness testified that he met with the plant manager and other management officials of Cemex to determine Cemex water needs over the next three years. Cemex said that its water use for the next three years would remain about the same as it has been in the recent past.
DRA's witness testified that San Gabriel's estimate of sales to Cemex was based on a ten-year average, and proposed instead an estimate based on the average of the two most recent recorded fiscal years. This produced an estimate of test year sales to Cemex of 250,685 hundred cubic feet (ccf) as compared to San Gabriel's estimate of 223,666 ccf. DRA's recommendation is more reflective of Cemex's current and anticipated water use, and will be adopted.
In regard to CSI, San Gabriel's witness testified that San Gabriel officers had met with representatives of CSI in May 2005 and were informed that CSI had decided to rehabilitate its existing on-site well to produce its own water and had spent $900,000 so far on the project, which is expected to be completed later in 2005. CSI will still rely on San Gabriel for part of its supply and as a backup source of supply. San Gabriel estimates that San Gabriel's sales to CSI will be reduced by over 566,000 ccf per year.
DRA challenged San Gabriel's assumption that CSI will use its entire 1,300 acre-feet per year (AFY) of water rights. DRA's witness testified that a CSI officer contacted by DRA could not give clear-cut information regarding amounts CSI intends to self-provide. DRA recommended that sales to CSI be projected at 545,700 ccf, a level 283,140 ccf higher than San Gabriel's test year estimate, reflecting a 50% reduction in sales compared to San Gabriel's projected reduction. As San Gabriel has not produced persuasive evidence regarding CSI water demand, we will adopt DRA's more conservative estimate.
Miscellaneous Revenues are revenues recorded in Accounts 611 and 614. The revenues recorded in Account 611 consist primarily of reconnection fees collected from customers, which San Gabriel based on a five-year average in its forecast. The revenues recorded in account 614 consist primarily of reimbursements received by San Gabriel from third parties, mainly from the County of San Bernardino. DRA accepts the amount proposed by San Gabriel for Miscellaneous Revenues in the forecasted TY 2006-2007, with one exception. In August 2005, San Gabriel received $116,909 from the West Valley Water District, acting as a disbursement agent on behalf of the United States Environmental Protection Agency (US EPA), for grant funds for the reimbursement of certain operation and maintenance (O&M) costs incurred at Plant F17. DRA recommends Miscellaneous Revenues be increased by $116,909 to reflect an expected annual level of grant revenues. DRA also recommends that if future grant proceeds are received by San Gabriel in excess of the $116,909, then the excess amounts should be included in the Water Quality Memorandum Account (WQMA) for future benefit to ratepayers. San Gabriel's witness testified that this is a one-time reimbursement. San Gabriel agrees to adjust the test year forecast by one-third of the amount, or $38,970. DRA asserts that the company's data response indicated that additional US EPA funds would be forthcoming. Thus, contrary to San Gabriel's position, these funds will continue to be paid to San Gabriel on an annual basis.
DRA's assumption that the US EPA will give San Gabriel a grant of $116,909 in each escalation year is speculative at best. Including $116,909 in the test year Miscellaneous Revenues would give the ratepayers three times the benefit of a one-time payment. Should additional grant money be received by San Gabriel, the company has agreed that that money would be recorded in its WQMA for the benefit of ratepayers. San Gabriel's approach to the allocation of the $116,909 is to amortize it over three years, increasing the water revenue account by $38,970 in the test year. San Gabriel's proposal is reasonable and is adopted.
VI. Operating and Administrative Expenses
Unaccounted for water is the amount lost through operations and leakage and is calculated as the difference between the total amount of water produced and the total amount water recorded for sales. DRA agrees with San Gabriel's proposed 6.2% unaccounted for water factor. It will be adopted.
San Gabriel seeks to develop a capability to supply reclaimed water to satisfy special needs of some customers. A San Gabriel witness described a series of communications between San Gabriel and the City regarding the possible purchase of recycled water from the City, but said the City failed to produce any definite information about the availability or price of recycled water. San Gabriel is very much interested in the City's still-pending Recycled Water Feasibility Study/Master Plan and will meet with City officials upon its completion.
The City took a different view of the recycled water issue. Its witness said San Gabriel has failed to propose a solution that helps reduce rates. The witness said the City generates over 11.5 million gallons per day (mgd) of wastewater and participates in a regional Recycled Water Master Plan to deliver recycled water to participating agencies. He said the City would like to enter into a recycled water agreement with San Gabriel but that San Gabriel has been unclear in its position to develop a suitable recycled water serving arrangement.
This issue generated much acrimony between the City and San Gabriel. The parties seemed to be talking past each other rather than with each other. Recycling wastewater is an important conservation measure.1 We remind the parties that the ALJ Division offers mediation services that may be useful in resolving these issues.
DRA reached an agreement with San Gabriel that San Gabriel's proposed $8,509,500 water costs (177.88/AF) forecast for TY 2006-2007 is reasonable. However, as DRA has recommended an adjustment to increase the company's projected sales to CSI by 650 AF, DRA has also increased the projected purchase water costs by $115,622 (650 AF x $177.88/AF) to $8,625,122.
San Gabriel contends that DRA's adjustment to water costs is inadequate, because DRA's higher cost estimate reflects only its forecast of higher sales to CSI and not its forecast of higher sales to Cemex, reflects only net sales rather than water production requirements (including the agreed upon 6.2% water loss factor), and is improperly based on average cost rather than incremental cost. If the Commission were to accept the higher estimates of sales to CSI and Cemex that DRA proposes, the increase in purchased water costs would be $209,102 rather than $115,622. Although these adjustments may affect purchased water costs, we disagree with San Gabriel about the need to adopt the higher estimate because actual purchased water costs go through a full cost balancing account.
DRA reached an agreement with San Gabriel that its proposed $4,795,500, or $0.094782 per kilowatt hour (kWh), forecast for TY 2006-2007 is reasonable. The actual purchased power costs go through a full cost balancing account.
San Gabriel estimates that its annual chemical expense will increase from the actual 2004 amount of $140,544 to TY 2006-2007 cost of $680,110, an increase of 384%. The forecasted increase is due to the resin replacement at Plant F17 beginning in 2005 and the projected additional cost beginning in 2007 for chemicals associated with the Sandhill treatment plant upgrade.
The treatment facility at Plant F17 is an ion exchange facility used for the removal of perchlorate. DRA concurs with San Gabriel on the amount for chemical costs for Plant F17.
For the Sandhill treatment plant upgrade, San Gabriel included projected chemical expenses for TY 2006-2007 based on 50% of projected 2006 expenses of $148,872 and 50% of the projected 2007 expenses of $404,107. San Gabriel based the projected 2007 increase on a comparison of the estimated chemical costs of operating the upgraded plant with the Cucamonga Valley Water District's costs of operating a similar water treatment plant.
In response to discovery by DRA, San Gabriel indicated that the projected in-service date for the Sandhill plant upgrade is not until August 2007 which is after the end of TY 2006-2007. Therefore, DRA recommends that the chemical costs for the Sandhill plant for TY 2006-2007 be based on San Gabriel's projected 2006 pre-update cost of $148,872, resulting in a $128,000 reduction to San Gabriel's proposed chemical expense.
We agree with both parties. We should avoid including an expense in the test year which will not be incurred in the test year. However, we should not deny the known expense in the escalation year. To resolve the issue, we will amortize the two years of the expenses over the three year period. Therefore, we will reduce San Gabriel's chemical expense by $42,700. ($128,000 ÷ 3 = $42,700 (rounded).) The reasonable expense is $637,410.
For the majority of the O&M expenses and Administrative & General expenses, other than payroll, San Gabriel forecasted expenses utilizing a five-year average of recorded data from 2000-2004, adjusted to 2004 dollars, and applied escalation factors in determining future amounts. In applying escalation factors for the test year and escalation years, San Gabriel utilized June 30, 2005 publications from the DRA Energy Cost of Service Branch (ECSB). DRA recommended that San Gabriel utilize the more recent ECSB memorandum, dated September 30, 2005 to update the inflation factors, and San Gabriel has agreed.
DRA did not take issue with the projected amount of materials and supplies expense included by San Gabriel, which was based on five-year average expense levels, escalated to test year dollars. Using the updated September 30, 2005 escalation factors, DRA's recommendations for materials and supplies expenses are: $142,300 for operations, $282,900 for maintenance and $40,300 for administrative and general expenses. These amounts are $1,500, $3,100, and $400 higher than San Gabriel's proposed amounts, respectively. San Gabriel does not object; DRA's recommendation is adopted.
San Gabriel's projected TY 2006-2007 O&M expenses include $628,306 for transportation expenses, which include a 1% escalation increase each year from 2005-2007 to adjust for the purchase of additional vehicles. After discussions with company employees, DRA says San Gabriel has not based the 1% on any calculations or studies. Thus, there is no support for the additional 1% increase factor. DRA recommends a TY 2006-2007 expense of $619,323, which is a reduction of $8,983, reflecting the removal of the additional 1% annual increases. DRA's recommendation is adopted.
In projecting TY 2006-2007 postage expense, the company applied non-labor escalation rates as well as the 5.4% postage rate increase. DRA agrees.
The maintenance expense element of outside services varies directly with the amount of physical plant. San Gabriel increased to $187,100 the recorded year 2004 maintenance expense amount to reflect both increases in plant and non-labor escalation rates. DRA recommended reducing maintenance expense by $9,900 to reflect DRA's proposed disallowance of new wells and emergency generators and DRA's application of more recent escalation factors. DRA also disagreed with San Gabriel's justification that the cost of maintaining mains, service connections, and hydrants will increase as the number of units of such plant increases; DRA estimated this cost based on a simple five-year average with no reflection of the increasing number of such facilities.
San Gabriel argues that maintenance expense necessarily varies with the volume of plant to be maintained. As quantities of plant increase over time, it is unrealistic to estimate future maintenance cost solely on a simple five-year average. We agree. As we are not disallowing new wells and generators, San Gabriel's estimate of this expense item is more reasonable than that of DRA, and is adopted.
San Gabriel estimated $287,795 in TY 2006-2007 for non-perchlorate related legal costs, based on a ten-year average expense level, inflated to 2004 dollars, then escalated to TY 2006-2007 utilizing the June 2005 escalation factors.
DRA reviewed the legal costs included in each of the 10 years included in the calculations and determined there was a significant impact from using early year expenses on the going-forward cost estimates. Analysis shows that the escalated cost for the two oldest years, 1995 and 1996, are significantly higher than any of the other years reflected. DRA recommends that non-perchlorate related legal costs be computed on a recent five-year average, inflated to 2004 dollars and escalated to the 2006-2007 test year level using the updated, September 30, 2005 escalation factors. This, it argues, is consistent with the five-year averaging methodology used for other accounts and removes the impact of abnormal cost levels. The result is DRA's recommended non-perchlorate related legal costs of $151,972, which is $135,824 less than the amount proposed by the company.
San Gabriel maintains that it requires outside counsel to assist in the assertion and protection of water rights, the pursuit of claims against those responsible for groundwater pollution and against governmental agencies for service duplication, defense against legal claims brought by others, and complex matters involving real property, easements, franchises, rights of way, company operations, and regulatory issues.
The president of the company testified that the variability of legal issues and of legal fees from year to year justifies San Gabriel's reliance on ten years' activity and legal expenditures, allowing a normalized projection of general legal expenses. He testified that in the first 11 months of 2005, the Fontana Division had incurred legal fees unrelated to groundwater contamination or this GRC that exceeds San Gabriel's test year estimate, and he expects the full-year cost for 2005 to be much higher than that estimate.
Outside legal expense is not as susceptible to forecasting as the more routine forecast of maintenance expense or payroll costs. Legal fees can come in chunks - high in one year, low in the next year. To provide for the possibility of high fees we will adopt San Gabriel's estimate, but to also provide for the possibility of average expense we will require San Gabriel to create a memorandum account to record outside legal expenses, capped at $287,795. Money not reasonably expended shall be returned to the ratepayers.
San Gabriel's witness testified that San Gabriel has spent considerable sums on legal representation to pursue its claims against groundwater polluters, including $939,000 in legal fees and expenses in 2003, $755,000 in 2004, and $558,000 in the first six months of 2005. He expects such legal fees to increase sharply due to complex litigation against polluters in the Fontana-Rialto area. San Gabriel has been a very active participant in the Inland Empire Perchlorate Task Force, which includes three other affected water purveyors in the Fontana, Rialto, and Colton area, state agencies, and specialized legal counsel, engineers, and consultants. He testified that much remains to be done to require the polluters to implement a clean-up of groundwater supplies contaminated with perchlorate. San Gabriel proposes to apply future recoveries in the WQMA and account for the investments as contributions for the benefit of ratepayers. Perchlorate related legal expenses are currently accounted for through the Water Quality Litigation Balancing Account and are not factored into base rates. DRA recommends that this methodology continue, and that amounts recorded in the Water Quality Litigation Balancing Account continue to be deferred until the outcome of the associated legal expenditures and litigation are known.
The methodology should continue but may be amortized in the next rate case.
San Gabriel's O&M expenses for TY 2006-2007 include $88,200 for Utilities and Rents, based on the actual 2004 amount, escalated to the test year level. Replacing the actual 2004 amount with the five-year average level (inflated to 2004 dollars) and escalated to TY 2006-2007 while using San Gabriel's proposed escalation factors results in a Utilities and Rents expense of $88,892. DRA's recommended amount for Utilities and Rents is $89,100. The difference between DRA's recommended amount and that proposed by San Gabriel is due to DRA's use of more recent escalation factors. San Gabriel agrees with DRA, as do we; it will be adopted.
San Gabriel's filing included payroll expense for TY 2006-2007 of $5,061,200. In projecting payroll expense, San Gabriel began with the actual employee monthly salaries as of June 1, 2005. It added all vacant positions as of that date as though they were completely filled and added proposed new employee positions. The resulting amounts were escalated to TY 2006-2007 by applying the June 1, 2005 ECSB Compensation per Hour Index; many positions were also increased by step increases.
DRA's recommended payroll expense for TY 2006-2007 is $4,516,000, a reduction of $545,200 from the company's filing. DRA made the following revisions to San Gabriel's calculations: (1) removed 11 vacant positions; (2) replaced the Compensation per Hour Index with ECSB's labor inflation rates published in September 2005; (3) removed the step increases; (4) replaced wages for newly filled positions with the actual salary amounts; (5) removed five of the 12 proposed new positions; and (6) removed four additional proposed new Water Treatment Operator IIIs and recommended advice letter recovery for these four new positions.
In D.05-07-044, issued in San Gabriel's Los Angeles County division GRC, the Commission adopted DRA's preference for ECSB's labor inflation rates rather than ECSB's Compensation per Hour Index to forecast in-house labor expense. In that light, San Gabriel has agreed to use the ECSB labor inflation rates, thereby reducing its proposed revenue requirement for TY 2006-2007 by about $94,800, while also agreeing to apply the September 2005 version of the ECSB escalation factors. Consequently, the proposed DRA disallowance is $450,000.
The payroll calculation used by San Gabriel in projecting the TY 2006-2007 payroll expense assumed that all existing vacant positions were filled. As of the date of the filing was prepared, San Gabriel had 13 vacant positions. As of November 14, 2005, 12 of the existing positions included in the filing were vacant. DRA recommends that the 12 positions that were vacant as of November 14, 2005 be removed in determining TY 2006-2007 payroll expense as it is normal to have some level of vacancies in any given period. In addition, for new employees that had been hired from the date of the company's filing through November 14, 2005, DRA replaced the projected salary included in the filing with the actual amount.
DRA's recommendation to remove the vacant positions is adopted. It is consistent with our decision in the recent Los Angeles Division rate case, D.05-07-044. In that decision, we did not include the vacant positions, indicating that adjustments should not be made for temporary vacancies absent a showing of extraordinary circumstances. The decision also indicated that most utilities will have vacancies and "to the extent there were vacancies in the recorded year, we should assume there will also be comparable vacancy savings in the test year and escalation years. (D.05-07-044 at p. 10.)
In addition to assuming that all vacant positions would be filled by the start of the test year, the company has also included costs associated with 12 new positions. The new positions, along with the projected hire by dates included in the filing, are as follows:
· Safety Specialist (July 2006);
· Customer Serviceman (January 2007);
· Meter Reader (January 2007);
· Water Treatment Supervisor (July 2006);
· Six Water Treatment Operator IIIs (July 2006);
· Plant Maintenance Man A (January 2007); and
· Water Treatment Operator (July 2006).
(Ex. 45, pp. 3-7; 3-8.)
DRA recommends that five of the proposed 12 new positions be removed, consisting of: two of the six proposed new Water Treatment Operator III positions; new meter reading position; new customer serviceman; and new Water Treatment Superintendent. For the remaining four Water Treatment Operator III positions that DRA recommends allowing, DRA recommends the associated costs be removed from the determination of the TY 2006-2007 costs and be allowed for recovery via advice letter after (and if) the Sandhill treatment plant upgrade is up and running and the positions are actually filled.
As of November 14, 2005, San Gabriel employed four Water Treatment Operator IIIs, plus it had two vacant Water Treatment Operator III positions. The California Department of Health Services (CDHS) requires the company to staff the Sandhill plant, after upgrades are complete, with two Water Treatment Operators with Grade III certification or above for 24 hours a day, seven days a week. The Sandhill plant currently is not staffed from 12:00 p. m., to 7:00 a.m., and on Saturdays and Sundays only one individual is employed for 8 hours each day. The Company explained that it needed the equivalent of 8.4 water treatment operators to maintain adequate staffing, in compliance with CDHS requirements on a "24/7" basis. To account for sick leave and vacation time, it requires ten operator positions for full staffing. DRA recommends that the costs associated with new Operator III positions be removed from base rates and recovered via advice letter after the Sandhill plant is in operation and the positions are actually filled. The Company has included these positions as though they were hired before July 2006, the start of TY 2006-2007. The company has indicated that the Sandhill plant upgrade will not be in service until August 2007, outside of TY 2006-2007. Consequently, DRA argues the associated payroll costs should not be included in the TY 2006-2007. San Gabriel responds that the new water treatment operators are absolutely essential, and must be hired before the upgrades are completed in order to undergo necessary training.
If the Sandhill plant is running by August 2007, it is necessary to employ, train, and qualify all the operators prior to start-up. That training is expected to take three to six months. We see no reason to require an advice letter filing to recover these costs, but because the new employees will be working less than half a year in the test year we will disallow one position. Five additional Water Treatment Operator IIIs will be authorized.
DRA would disallow one meter reader position, one customer service position, and one water treatment superintendent because labor cost escalation should cover the increased payroll costs. Customer service and needed supervision are day to day questions particularly within the relationship of the company to its customers. We are not in the business of micro-managing Class A water utilities. DRA's recommendation is rejected.
In addition to applying the ESCB's Compensation per Hour Index to the June 1, 2005 salaries, San Gabriel has included step increases for numerous positions. This results in a overstatement of labor expense. In the recent Los Angeles Division GRC (D.05-07-044 at p. 10.), the Commission determined that step increases should be removed. We will follow D.05-07-044 and eliminate step increases.
DRA reduced projected payroll expense for both existing and new employees by substituting ECSB's September 2005 Labor Inflation Rates for San Gabriel's use of ECSB's June 2005 Compensation per Hour Index. San Gabriel agreed to apply the more recent escalation factors, which we adopt.
San Gabriel proposed $828,000 for payroll expenses related to vacation, holiday, and sick leave. After applying DRA's recommended revisions, vacation, holiday, and sick leave expenses are reduced by $90,000. The company agrees with DRA. We will adjust this category to reflect our adopted revisions to payroll.
San Gabriel calculated $301,639 for 401(k) expenses for TY 2006-2007. The amount was calculated based on the estimated 2005 company contribution rate of 7.34%. DRA agrees San Gabriel's use of the 7.34% contribution factor is reasonable. We will change the escalation factor from the Compensation per Hour Index to the Labor Inflation Rate and recalculate the expense based on our adopted revisions to payroll.
For health insurance expenses, San Gabriel inflated the 2005 premiums by an assumed increase of 14.19%; and for dental insurance expenses by inflating the 2005 premiums by an assumed increase of 6%. DRA agrees with San Gabriel's forecasts and methodology. We will modify the health and dental insurance expense to reflect the impact of our revisions to payroll.
San Gabriel's projected TY 2006-2007 injuries and damages and property insurance expense is $626,600. This includes costs for an umbrella insurance policy covering general liability, automobile liability and property damages, and workers compensation premiums. Of the total $626,600, $12,300 is for property insurance, $390,000 is for workers compensation insurance, and the remainder is for liability.
San Gabriel's filing includes $236,600 for non-workers compensation ($626,600 total amount - $390,000 for workers compensation) related injuries and damage costs, consisting of business, property, and liability insurance. In determining the costs associated with the umbrella insurance policy covering general liability, automobile liability, and property damages, San Gabriel's TY 2006-2007 estimate was based on the actual 2005 invoiced amount, escalated by 10% for 2006 and 2007. The 10% escalation rate is consistent with insurance cost escalations DRA's consultants have seen in recent years, and DRA finds the factor to be reasonable. DRA accepts San Gabriel's projected insurance costs.
San Gabriel projects worker's compensation insurance premiums for its Fontana Division of $390,000 in TY 2006-2007, an amount which includes increases due to two factors: increased payroll and assumptions regarding its experience modification factor (Ex Mod).
The Ex Mod is a percentage factor applied to the determined premiums, which either raises or lowers the premium for individual companies. According to San Gabriel, its insurance broker calculated that San Gabriel's Ex Mod will increase from 83% to 92% effective July 1, 2005. This is an increase of 10.8%, which will increase the company's workers compensation insurance premium by the same percentage. In its calculations for the following plan year, the year beginning July 1, 2006, San Gabriel increased the Ex Mod factor to the full 100%. DRA claims that the 100% Ex Mod factor is inconsistent with actual experience for San Gabriel.
DRA recalculated the projected workers compensation insurance expense. First, DRA replaced the company's projected percentage increase in overall costs with the overall percentage of payroll cost increase recommended by DRA based on its payroll adjustments previously discussed. Second, DRA removed the company's projected Ex Mod factor of 100%, to reinstate the most recent Ex Mod factor of 92%. The result is a recommended TY 2006-2007 workers compensation insurance expense of $333, 600, which is $56,400 less than the amount proposed by San Gabriel.
Additionally, over each of the last three years, San Gabriel has received refunds of its workers compensation expense payments. These refunds have been flowed by San Gabriel to retained earnings and are not factored into the workers compensation expense calculation. The annual refunds for each of the last three years for the Fontana Division were $1,754 in 2005, $51,150 in 2004 and $17,988 in 2003. As ratepayers pay the costs of workers compensation insurance in rates, they should also receive the benefit of the refunds received by San Gabriel for such insurance costs. DRA recommends that the workers compensation expense be offset by the three-year average of refunds received, or $24,000.
A San Gabriel witness testified that for seven of the past ten years San Gabriel's Ex Mod factor has exceeded 100%. Because a 100% factor represents the statewide, industry-specific average loss rate in a given year, using a 100% Ex Mod is equivalent to normalizing workers compensation insurance expense - an appropriate approach for estimating test year costs.
We will modify San Gabriel's worker's compensation expense by adjusting for the payroll increase which we have adopted and by offsetting the expense by the three-year average of refunds received, $24,000. We will not adjust the Ex Mod factor as requested by DRA. For seven of the past ten years it has exceeded 100% for San Gabriel. Refunds should ameliorate the expense.
San Gabriel's filing includes TY 2006-2007 regulatory commission expenses of $191,400. Included is $187,333 for the amortization over three years of San Gabriel's projected $562,000 cost for this rate case. The $562,000 cost includes $390,000 for outside legal fees. DRA agrees with this expense and its amortization. It is adopted.
San Gabriel projects uncollectible expenses based on a five-year average uncollectible rate of 0.2850%. Considering the consistent annual decline in the uncollectible rate, DRA recommends the last two-year average be used in for determining uncollectible expense. DRA and San Gabriel have agreed to the use of a two-year average rate of 0.1951%. San Gabriel's originally proposed uncollectible expense was $123,600. DRA's recommended uncollectible expense, based on the DRA projected 2006-2007 revenues at present rates and DRA's proposed uncollectible factor of 0.1951%, is $85,800. DRA's recommendation is adopted, modified to reflect our projected revenue.
San Gabriel incorporated franchise fee expenses based on a five-year recorded average franchise fee rate of 0.8091%. DRA and San Gabriel have agreed that this rate is reasonable. It is adopted.
VII. General Office Allocation
The general office allocation consists of common expenses that are not directly assigned to an operating division. These costs are allocated between the Los Angeles Division and the Fontana Division based on a four-factor allocation formula. DRA accepts San Gabriel's allocation. It is adopted.
VIII. Taxes
The difference in income taxes estimated for TY 2006-2007 between DRA and San Gabriel are due to the differences in revenues, expenses, and rate base, and San Gabriel's failure to reflect the impacts of the American Jobs Creation Act of 2004 on its income tax expense.
The American Jobs Creation Act of 2004 provides for a deduction equal to 3% of qualified production activities income in 2005 and 2006 and 6% of qualified production activities income in 2007 and 2008. Under the Act, the production of potable water, including the acquisition, collection, and storage of raw water, qualifies as a production activity to which the deduction is applicable. As the applicable deduction is 3% for 2006 and 6% for 2007, DRA utilized an average deduction rate for TY 2006-2007 of 4.5%. San Gabriel has estimated the percentage of its net income applicable to production activities to be 51.9%. DRA has reviewed these estimates and finds them reasonable.
The application of the 51.9% production activities factor to DRA's calculated taxable income at present rates, along with the application of the 4.5% average deduction rate, results in a $246,100 reduction to taxable income. In flowing through the impact of the 2004 Act, the 51.9% production activities factor should be applied to the ultimate taxable income for federal income taxes resulting from this case, with the average 4.5% deduction rate then applied to determine the production activities deduction for income tax purposes. This also impacts the net-to-gross multiplier, reducing the effective FIT rate to 34.18%.
San Gabriel disagreed with the application of this adjustment stating that the Commission should open an OII or Order Instituting Rulemaking (OIR) to analyze the tax legislation and IRS guidance for ratemaking purposes. DRA says the Company would have the Commission ignore this tax deduction and ignore the reduction in income taxes that will result until some unknown future date. This is neither reasonable nor appropriate. The 2004 Act is already in effect, was in effect for tax year 2005 and beyond, and includes the production of portable water as an item of qualified production income to which the deduction is applied. San Gabriel points out that the Commission did not apply the impacts of the 2004 Act in the Company's recent Los Angeles Division rate case (D.05-07-044), and that it should not deviate from its past precedent. D.05-07-044 is irrelevant in this instance. D.05-07-044 was based on TY 2004-2005. The Act is in effect for TY 2006-2007 and is a benefit that is available to San Gabriel. We adopt DRA's recommendation.
DRA calculated tax depreciation for state and federal income tax by applying the ratio of DRA's estimate of net plant to San Gabriel's estimate of net plant, to San Gabriel's tax depreciation estimate.
In calculating the interest deduction, DRA used its recommended rate base, multiplied by DRA's recommended weighted cost of debt of 3.39%. The interest deduction is determined by applying the weighted cost of debt to the final rate base. The Company has agreed that this is the correct methodology. Since DRA has reached a settlement with the Company on capital structure and rate of return, the resulting weighted cost of debt for TY 2006-2007 is 3.39% based on the average of the 2006 and 2007 weighted cost of debt presented in Joint Exhibit 85. In the Joint Comparison Exhibit, Exhibit 88, DRA's final position reflects the interest deduction based on DRA's recommended rate base and the settled upon weighted cost of debt of 3.39% for TY 2006-2007. DRA and San Gabriel are in agreement on the methodology for calculating the interest deduction for income tax purposes and on the weighed cost of debt rate to use. The only remaining difference is the rate base amounts to which the weighted cost of debt is applied.
Taxes Other Than Income include ad valorem taxes (property tax) and payroll taxes. San Gabriel included in TY 2006 - 2007, $1,034,500 for ad valorem taxes and $491,800 for payroll taxes. DRA's recommended TY 2006-2007 ad valorem taxes are $766,200 and payroll taxes are $431,700.
DRA's ad valorem figure differs from San Gabriel's due to DRA's different rate base estimates, which are discussed later. Payroll taxes include Social Security tax, Federal Insurance Contribution Act (FICA), Federal Unemployment Tax Assessment (FUTA), and State Unemployment Tax Assessment (SUTA).
DRA's recommended TY 2006-2007 payroll tax expense is $431,700, which is $60,000 less than the amount proposed by San Gabriel. DRA's recommendation flows through the impacts of DRA's recommended adjustments to payroll. San Gabriel and DRA agree on the amount for Other Taxes except for payroll. We adopt their recommendation but will use our independent findings on payroll.
IX. Components of Rate Base
San Gabriel's Fontana Division serves approximately 43,000 customers with approximately 46,000 acre-feet per year. The system has 37 water production wells with a peak available production of 71 mgd, 12 storage reservoirs with an aggregate usable storage capacity of 28.4 million gallons, one water filtration plant (Sandhill) with a capacity of 17 mgd, and approximately 3.4 million feet of distribution and transmission pipelines. It has a summer peak day demand of approximately 67 mgd and a fire flow storage requirement of approximately 2.5 million gallons. It has been experiencing an average growth of approximately 1,300 new customers per year and expects this growth rate to continue.
Most of the controversy affecting rate base estimates concerns San Gabriel's planned investments in utility plant. Assessing the need for these investments depends on understanding the current water supply system serving Fontana Division customers and the extent to which utility plant additions are required to meet base load and peak demand reliably and efficiently and in compliance with CDHS Safe Drinking Water Act requirements.
The Fontana Division is confronted with increased demand throughout its service area as the result of rapid new development. Recognizing the need for an updated plan to address the growing demands on its water supply and distribution system, in October 2003, San Gabriel retained an engineering firm that specializes in water system design to prepare a comprehensive Water Master Plan. That Master Plan includes a water demand forecast model and a hydraulic water distribution system model to analyze future system demands and corresponding infrastructure requirements. The analysis identified areas within the Fontana Division's service area that will require new sources of water supply, additional storage to provide operational flexibility and to provide for peak demands and/or fire flow requirements, and new booster plant facilities.
The Master Plan reviewed existing sources of supply and the ability to comply with current and proposed state and federal drinking water requirements, including revisions to the federal Safe Water Act, the federal Unregulated Contaminant Monitoring Rule (UCMR), development of a vulnerability assessment, development of an emergency response plan, the Disinfectant/Disinfection By-product Rule (D/DBPR), State UCMR, the Drinking Water Source Assessment and Protection (DWSAP) Program and the interim Enhanced Surface Water Treatment Rule (ESWTR).
The Master Plan addressed the rapid growth in the undeveloped northerly portions of Fontana Division's service area and additional industrial growth in the southerly areas, both of which will require additional water supplies to meet customer demand and increased fire flow requirements. The increased water demand in these areas will require new wells along with new reservoirs (for fire flow requirement and peak demand), booster pumps, and transmission and distribution pipelines to provide necessary flows at appropriate pressures.
According to the Master Plan, approximately 25 mgd of additional groundwater supply is needed by the year 2010 in order to meet increased demands and to increase the reliability of the system. The Master Plan recommends that the Fontana Division increase its water service reliability during emergency situations when wells are unexpectedly taken out of service. Emergency situations can include contamination and extended power outages, which can cause up to three wells to be placed out of service. The Master Plan recommends that the Company have redundant well capacity for at least three 2,000 gpm wells. The Master Plan recommends a total of eight new groundwater production wells (including three wells to provide redundant well capacity), each with a capacity of approximately 2,000 gpm, for a total capacity of approximately 16,000 gpm, be installed prior to 2010.
In the short term, the Master Plan includes budgeting for the installation of groundwater production wells, reservoirs, boosters, a complete Supervisory Control and Data Acquisition (SCADA) system, groundwater treatment facilities, and improvements to the Sandhill plant to maintain and improve water service reliability. The Fontana Division's most reliable source of supply is groundwater produced from the Chino Basin. Emphasis was placed on this source of supply to address anticipated water demands. A complete SCADA system will improve operation efficiency and reliability. Individual projects are discussed below.
The Master Plan concluded, among other things:
· That the Fontana Division has a current deficiency of 19 mgd under drought conditions, requiring construction of new and replacement wells that will produce at least 25 mgd as well as construction of a 7 mgd perchlorate treatment facility that will treat three contaminated wells, in order to overcome the current deficiency, meet year 2010 maximum day demands under drought conditions, and provide sufficient redundancy during emergency interruptions.
· That evaluation of required storage capacity to meet pressure and supply equalization, fire suppression, and emergency needs indicates current capacity shortages in the Baseline and Highland Zones, which will grow by 2010 to 4.5 mg and 1.4 mg, respectively.
· That construction of new reservoirs at six specified sites, some of which will provide backup when primary reservoirs are shut down for repair and maintenance, will overcome storage shortages projected for 2010 and will provide effective storage reliability in the Highland, Baseline, and Alder Zones.
DRA recommends that: costs for seven of the eight requested new wells be disallowed along with the associated plant additions; five of the nine requested new reservoirs be disallowed along with the associated plant additions; the Sandhill plant project costs included in plant by San Gabriel beginning in 2005 be removed from plant; the 2008 perchlorate treatment costs be excluded from Company funded plant and included in plant when it is known and measurable as contributed plant; and the proposed cost for mains be adjusted to reflect an historical level of expenditures.
The basis for DRA's recommendation is that "the Company's request for additions to plant appears to be structured on the Company's need to meet its peak day demand. While the Company must have sufficient resources to meet its peak day requirements, it is not appropriate for ratepayers to fund facilities to produce that requirement on a daily basis. A system that produces the peak day demand would have excess capacity that is not used and useful to ratepayers over the rate period. Alternative sources of supply, such as the outside purchases and emergency purchases relied on in the past, should be incorporated in the Company's forecast." (DRA Opening Brief, 37-38.)
DRA notes that the Company's Master Plan estimates a peak demand requirement of 73.8 mgd, which is well in excess of the 2005 peak demand of 66 mgd. Based on the Master Plan, the available supply from wells was 59 mgd, to which DRA adds the wells back in service that increase supply by 17.4 mgd, plus 2.9 mgd for the well which DRA recommends be allowed, resulting in a total supply from wells alone of approximately 79.3 mgd. This supply from wells does not include the supply from Lytle Creek flow or purchases. The supply exceeds the Master Plan requirement of 73.8 mgd by 5.5 mgd. DRA concludes that the Company's supply is sufficient to meet its requirements at this time. Thus, seven of the eight additional wells requested and the upgrade to the Sandhill plant are currently not required.
The District asserts that the Company's own evidence shows that it has sufficient capacity to adequately serve all its customers. Further, growth can be accommodated by adding one well a year. Therefore, the maximum expansion which can be justified for the three years involved with this GRC is three wells. The District says that the current well capacity of San Gabriel equals 87.83 mgd and the entire water production capacity totals 100 mgd. The largest maximum demand for any single day is 66 mgd. San Gabriel's expert witness testified that the system should have a redundancy factor added to peak demand to accommodate wells lost to drought, electrical outages, etc. He recommended 8.6 mgd. Therefore, the total capacity needed to serve the existing customers is 74.6 mgd. Consequently, San Gabriel already can meet its current demand of 66 mgd and still have a reserve of 34 mgd.
The City supports the water supply system analysis of the District. The City emphasized that San Gabriel's proposed system upgrades of $89,500,000 would be in addition to the current rate of about $71,000,000, which would create an intolerable burden on the ratepayers, especially the residential ratepayers.
The Commission adopted its Water Action Plan in December 2005. Among other objectives the plan seeks to maintain the highest standards of water quality.
We said:
Water quality is vital to the health of consumers. Delivering safe water requires a reliable infrastructure. We will bolster our current collaborative relationship with the enforcers of water quality standards, the Department of Health Services and the Federal Environmental Protection Agency, so that problems are identified and acted upon as quickly as possible. (Plan, p. 25.)
. . .
The water infrastructure in California needs significant improvement. We will provide financial incentives and direction to encourage investment in infrastructure needed to improve water quality. (Plan, p. 3.)
The Water Action Plan identified policy objectives that will guide the Commission in regulating investor-owned water utilities and highlights the actions the Commission anticipates or will consider taking in order to implement those objectives. The objectives are: (1) maintain highest standards of water quality; (2) strengthen water conservation programs; (3) promote water infrastructure investment; (4) assist low-income ratepayers; (5) streamline regulatory decision making; and (6) set rates that balance investment, conservation, and affordability. Since San Gabriel's instant application was filed before the adoption of the Water Action Plan, it did not specifically make any request to implement the objectives of the Water Action Plan. However, the utility should request the Commission to implement those objectives soon.
The CPUC requires each Class A water utility to file a Water Management Program with each GRC filing. D.90-08-055 requires all Class A utilities to submit, in each GRC, a Water Management Program with a 20-year horizon. The Water Management Program forecasts supplies and demand side management impacts out to a 20-year horizon. We use these Water Management Programs as a basis for pre-approval of major water supply projects that require a long term commitment, i.e., longer than the three-year GRC time frame.
San Gabriel has summarized how it developed its long range forecast. It retained Stetson Engineers in October 2003 to prepare a comprehensive analysis of the Fontana Division's needs for major water supply, storage, and delivery projects in both the near and longer term. The Fontana Water Company Water System Master Plan was completed in April 2005. (Ex. 13.) Nearly 300 pages in length (excluding appendices) with over 100 tables and more than 50 figures and maps, the Water System Master Plan reviews relevant legal and regulatory requirements, assesses historical water production trends and forecasts water demand for the Fontana Division in the short term (through 2010) and long term (through 2025), considers opportunities for regional water cooperation, reviews available water supplies and water supply facilities, evaluates water treatment needs, provides a hydraulic analysis of the water pumping, storage, and distribution system, and assesses the condition of the Fontana Division's water mains. On the basis of these analytic elements, the Master Plan then recommends a set of detailed priorities for implementing facilities and improvements, proposes an implementation schedule, and forecasts the relevant budgetary needs.
We have reviewed the Master Plan and find that it meets the standards of our Water Action Plan. Although we do not endorse every aspect of the Master Plan, we have analyzed, as set forth below, those facilities which are in controversy.
San Gabriel calculated utility plant in service for TYs 2006-2007 and 2007-2008 based on construction budgets, estimated advances for construction, contributions in aid of construction (CIAC), and items to be retired. The construction budgets include provisions for several capital projects which are expected to improve the system's ability to meet customer demands for safe, reliable water service, consistent with the guidance provided by the Water System Master Plan. These projects include plans to construct eight reservoirs and eight new wells over the next four years as well as upgrade the Sandhill plant to allow it to treat State Water Project (SWP) water and to enhance its capacity to treat water from Lytle Creek.
The calculations of proposed test year utility plant in service exclude investments after 2005 in two projects, the Sandhill plant upgrade project and the new headquarters complex, which are proposed to be added to rates by advice letter. These additional investments in utility plant and their proposed ratemaking treatment are discussed below in the context of each project.
The forecasted company-funded capital expenditures are $28.3 million in 2005, $28.3 million in 2006, $18.5 million in 2007, and $14.7 million in 2008. (Ex. 9, p. 20.) San Gabriel expects to meet its capital budget requirements by a combination of internally generated funds, bank borrowing, and new mortgage bonds.
Rather than approving specific projects, we believe the most equitable way to provide for capital improvement recovery in rates is to continue the solution found reasonable in D.04-07-034 to limit rate base growth to 10% per year. (D.04-07-034, p. 66.) We are not disposed to dictate to San Gabriel which plant will be constructed in which order; that is a management decision. However, as discussed below, the investment in the Sandhill Surface Water Treatment Plant is excepted from this 10% rate base cap. We will resolve "used and useful" issues in its next GRC, at which time a major concern will be whether the Company has maximized its efforts to obtain contributions from developers and others to pay for plant needed to meet growth. The need for various infrastructure improvements is discussed below.
The Sandhill plant is a "diatomaceous earth filtration system for surface water" that began operation in 1965. The plant relies on surface water diversions from Lytle Creek but often must be shut down and is unable to use that surface water during (and often for months following) storms and periods of heavy snow melt, when Lytle Creek has high levels of turbidity that exceed the current treatment capability of the Sandhill plant. The other source of supply for the Sandhill plant is SWP water that must be blended with Lytle Creek surface water before it can be treated. These blending requirements restrict the capacity of the Sandhill plant to the availability of useable Lytle Creek surface flow. The Sandhill plant must be operated in compliance with increasingly stringent state and federal safe drinking water regulations, including regulation governing Cryptosporidium, Giardia, and byproducts of the disinfectants used to control those organisms. Lytle Creek surface water flow is San Gabriel's lowest cost water. Thousands of acre-feet each year are lost because of impurities in the water. Hence, the upgraded Sandhill surface water treatment plant.
Prior to 1960, the only treatment provided for Fontana Division's surface water supply from Lytle Creek was at Fontana Union Water Company's (Fontana Union) afterbay, where screens removed large debris such as twigs and moss, and water was chlorinated as it entered a Fontana Union transmission pipeline. In 1960, San Gabriel joined with Fontana Union to build a surface water treatment facility including a microstrainer and chlorination facilities owned by San Gabriel. Upon notification by CDHS in 1962 that the microstrainer provided inadequate treatment, San Gabriel selected diatomaceous earth (DE) filtration as a replacement and in 1965 completed installation of a 10 mgd DE surface water filtration treatment plant, later expanded to 20 mgd, which CDHS approved in1968 as adequate for treating Lytle Creek surface water but not SWP water.
After several years' operation, the limited capacity of DE filtration to deal with high turbidity became apparent. The passage of clay through the DE filters caused effluent turbidity to rise to the maximum level permitted under federal and state regulations, making it necessary under such circumstances to shut down the plant. The required shutdown of surface water processing through the Sandhill plant has deprived the Fontana Division of thousands of acre feet of low-cost surface water, including over 25,000 acre feet just in the first five months of 2005.
In 2002, laboratory tests showed that clay can easily be reduced or removed by a pretreatment process of coagulation, flocculation, and sedimentation, making the Lytle Creek surface flows filterable under high turbidity conditions. These factors, plus the fact that thousands of AFY of available low-cost surface are lost due to clay, led San Gabriel to design and install upgrades and modifications to the existing DE treatment process to add the necessary pretreatment facilities.
CDHS has authorized San Gabriel to treat SWP water at the Sandhill plant, but with the restriction that the untreated SWP water must be blended with Lytle Creek surface water at a ratio not exceeding 80% SWP water and not less than 20% Lytle Creek water.
The result is that when Lytle Creek flows are low, particularly during summer months when the demand for water is greatest, the company can only treat correspondingly small quantities of SWP water. Even when rainfall is ample, the Lytle Creek flows are often unusable, due to excess turbidity, and, although the Sandhill plant's theoretical rated capacity is 20 mgd, its useful capacity is reduced to a maximum of about 17 mgd because the backwash cycle requires taking filters off-line and using a substantial amount of water for that function.
The planned upgrades and pretreatment facilities will permit the Sandhill plant to treat 100% Lytle Creek surface water, 100% SWP water, or any blend of the two. This will restore the full usefulness of the Sandhill plant even when Lytle Creek surface water is unavailable or too muddy, because the plant will be able to process SWP water.
The Water System Master Plan recommends modifying the Sandhill plant to eliminate the need for blending, to expand plant capacity from 17 to 29 mgd, and to obtain additional access to SWP water, in order to allow San Gabriel greater flexibility in managing its water supply sources both in the short and long term. The San Bernardino Valley Municipal Water District (Muni) has agreed to increase its commitment to provide SWP water to the Fontana Division from the current allowance of 3,000 up to 5,000 AFY, and that Inland Empire Utilities Agency also has committed to provide SWP water for use at the Sandhill plant once the planned upgrades are completed.
San Gabriel expects the Sandhill plant upgrade project to cost approximately $35 million, to which must be added staffing and maintenance.
San Gabriel's cost-benefit analysis indicates that the Sandhill plant upgrade project will pay for itself in two years. Among the project's significant benefits is that additional water supplies are made available in the northern portion of the system, closer geographically to customer demands and readily transported by gravity, which will allow San Gabriel to reduce the quantities of far more costly Chino Basin supplies having to be boosted to higher elevations in the distribution system at substantial energy cost.
DRA argues that the company's own witnesses do not agree whether the supply can be relied on the in the summer to meet peak demands and there are no formal contractual commitments for providing additional supply. DRA believes that supply exists to meet the average requirements and if the Sandhill plant cannot provide supply to meet peak demands, there is insufficient justification to allow the addition in rates. DRA recommends the advice letter treatment be denied and the cost and used and usefulness of the plant determination be deferred until the next GRC.
DRA says that San Gabriel's testimony indicates that the plant start-up date is August of 2007. The plant is not used and useful in 2005, won't be used and useful in 2006, and may be used and useful in late 2007, which is after the TY 2006 - 2007. In A.02-11-044 (D.04-07-034), San Gabriel requested that it be allowed to upgrade the Sandhill plant at an estimated cost of $9.8 million. In two years the cost has escalated to $35 million. San Gabriel's testimony points out that the scale of scope of the Sandhill project was changed significantly during the time between these two estimates.
DRA's primary concern with San Gabriel's proposed Sandhill plant upgrade is that San Gabriel has reflected $12 million of the estimated $35 million cost in plant in service and is proposing to collect the remaining $23 million through advice letters. As an alternative, DRA recommends that the projected $12 million of cost in 2005 be removed from plant. The plant upgrade will not be in service in 2005. The next GRC is the proper time to make a determination whether the final cost is appropriate and to determine the actual increase in capacity that will occur as a result of the upgrade.
The Sandhill plant's primary function will be as a baseload unit, operating as nearly as possible on a 24-hour, seven-days-per-week basis to make maximum possible use of San Gabriel's most economical sources of supply- Lytle Creek surface water and SWP supply purchased through Muni. Delivering those economical supplies into San Gabriel's distribution system near the highest point in the Company's service area not only will maximize use of inexpensive supplies, but also will minimize the cost of power for pumping water to the point of use. It is needed and should be completed.
The most difficult issue to resolve regarding the Sandhill plant project is how the cost should be passed into rates. DRA proposes to disallow rate base treatment of investments already made until San Gabriel's next GRC three years from now. San Gabriel's proposal would allow rate base treatment of the year 2005 investment while reflecting succeeding years' investments in rates advice letter filings effective January 1, 2007, 2008, and 2009.
While we have elsewhere established a limit on the growth in rate base, in part to avoid determining the timing of specific investments and to leave to management discretion the order in which these needed investments will be made over the next three years, we exempt the ratebase increases caused by investment in the Sandhill facilities from this cap. We do this because this investment is a large single investment that will necessarily go into ratebase over multiple years. We will allow rate base treatment of the year 2005 investments and will allow succeeding years' investments to be added to rate base by advice letter filings filed by November 15th to be effective January 1, of the following year. The costs of the Sandhill project should be capped at $35 million.
The Water System Master Plan recommends construction of a total of eight new Chino Basin wells located to provide supplemental water to specific pressure zones to help meet fire flow requirements. The new well at Plan F7 is required to meet projected increased customer demand and fire protection requirements. The Master Plan recommends that four existing wells be replaced based on advanced age and remaining service life projections. The wells are at least 75 years old.
San Gabriel's proposed construction plan differs slightly from the Master Plan. It proposes to construct eight wells over the next four years, seven in the northern and western portions of the service area where additional supply is needed and one in the southern portion to replace an existing damaged well. These plans encompass seven of the eight new wells recommended by the Master Plan. San Gabriel plans for only one of the replacement wells called for by the Master Plan to be drilled in 2007. San Gabriel said it needs these new wells to pump into reservoirs now under construction, which will enhance San Gabriel's ability to provide effective disinfection and to adjust flows from the reservoirs into the distribution system in accordance with customer demands, and to provide water for fire suppression purposes without causing an abrupt pressure loss or water outage.
DRA says that the Company's request to add eight wells is based on the perceived need for additional supply, which DRA claims is not needed. DRA recommends that only one well, constructed in 2005, be allowed in rates. DRA points out that in A.02-11-044, the Company requested and was allowed three wells that were not put in service as projected in 2003 and are again being requested in this case. According to the Master Plan, the water demands under normal weather conditions are estimated to be 54,000 AFY in the short-term (2010), while the production available as of April 11, 2005 was 66,246 AFY. DRA concludes that the current system has sufficient supply to meet and even exceed the projected short-term needs of 54,000 AFY without the added supply from surface water and emergency purchases. DRA recommends that only one well be allowed in rates at this time. The removal of the seven wells reduces plant by $700,000 in TY 2006-2007, and $700,000 in escalation year 2007-2008.
We have discussed San Gabriel's need for new facilities, which includes new wells and other plant. The issue is not need, but who pays. It is apparent that the need is clear and timing is important. Facilities take time to construct, test, and train staff to operate. Meeting 2010 requirements requires starting now. Because new wells are needed to meet the demands of new customers, those new customers should be contributing to provide the plant necessary to serve them. San Gabriel has planned well to provide a first class water system, but sadly lacks a first class plan to pay for it without beggaring its current ratepayers.
The Master Plan recommends installing a treatment facility at Plant 25 to remove perchlorate from groundwater produced at three wells in close proximity to each other, all of which are currently contaminated above the notification level of six micrograms per liter. The Master Plan recommends use of the same resin-based ion exchange process (which is best available treatment technology) presently in use. San Gabriel plans to construct the wellhead treatment facility in 2008.
DRA is concerned that the Company's requested addition in 2008 of the treatment facility ignores the fact that the cost of the facility should be borne by the parties responsible for the contamination. DRA says that in A.02-11-044, San Gabriel contended that it could not put on hold the construction of treatment plants while waiting for litigation proceeds because it urgently needed the restoration of lost production capacity. DRA argues that the Commission approved the Company's request for seven facilities in A.02-11-044, but no facilities were constructed. DRA submits that San Gabriel's conception of urgency varies from the ordinary sense of the word. How can the Commission be confident it will actually build the facility in 2008 when it failed to do it over the past three years despite the alleged exigency of restoring this source supply? DRA recommends the $2 million of cost for the treatment facility be removed from plant additions because the cost is projected far enough into the future that we can determine the responsible parties' obligations prior to its in-service data. The cost of this project should be reflected as contributed plant if the plant is ultimately constructed.
DRA has not carefully read D.04-07-034. In that decision, we did not approve a request for seven facilities. What we did do was impose a rate base cap and said:
"10. San Gabriel needs flexibility within the rate base cap to make its own decisions about the need for and timing of projects, and to make changes and substitutions as necessary to its proposed construction program." (D.04-07-034, Finding of Fact 10 p. 66.)
We do agree with DRA that the costs of this facility should be treated as CIAC, if the company recovers funds from its contamination lawsuits. But, in the meantime, the facilities are needed and should not be delayed pending the outcome of litigation. Preliminarily, costs should be recorded in construction work in progress (CWIP).
San Gabriel plans to construct eight new reservoirs over the next four years to improve system reliability, provide needed storage for operating, emergency, and fire fighting purposes, and to increase storage capacity in each of the Company's five pressure zones. Two of these projects were planned for construction during 2005. Three are planned for 2007 and three for 2008. Water stored in reservoirs is used for normal operations and to satisfy peak demands and fire flow requirements that otherwise would need to be provided from additional wells and booster facilities. The Master Plan identifies several portions of the service area that may be vulnerable in the event existing storage facilities are not available due to maintenance needs or shortage of supply. The Master Plan recommends that new reservoirs be added in the Baseline, Highland, and Alder pressure zones. New reservoirs are needed to serve proposed new wells. New reservoirs are needed in the northern portion of the Fontana Division service area to serve new residential development.
DRA recommends that three of the eight proposed reservoirs not be allowed in rates. DRA would reduce TY 2006-2007 plant by $727,500 and TY 2007-2008 plant by $1,527,000. DRA's recommendation rests on its perceived lack of need for additional capacity. DRA reasons that according to the Master Plan, San Gabriel currently has 30.28 mg of useable storage capacity. Based on the requirements for equalization, fire suppression, and emergency, the Company's total storage requirement is 22.65 mg. By the year 2010 and 2025, the projected requirement is expected to be 24.81 mg and 31.12 mg, respectively. The current existing capacity exceeds the current and short-term needs of the Company and is approximately 1 mg short of the long-term requirements. DRA believes that the addition of the requested reservoirs and other facilities is excessive and could be related to future growth. To the extent that any addition to plant is growth-related, the cost of the added facilities to serve that growth should be contributed by developers.
We have previously discussed our reasons to accept San Gabriel's proposed improvements to its water system. The remaining issue is source of funds. We believe San Gabriel has neglected to emphasize developer funds to provide new facilities for new customers. The need for reservoirs arises not only to serve current ratepayers, but also to serve new customers. We agree with DRA that new customers should contribute toward new facilities. We need not decide at this time which facilities will serve new customers. In San Gabriel's next GRC, we can sort that out. We are confirming our rate base cap of 10% per year, but we will review which part of that 10% was investor funds and which part was, or should have been, contributed.
San Gabriel requests that we should approve rate base amounts that include projected investments in booster stations, security equipment, emergency generators, and transmission mains associated with the wells and reservoirs that may be constructed.
DRA would disallow the equipment associated with the wells and reservoirs which it recommends be disapproved. We prefer to allow San Gabriel to choose the facilities it deems necessary under our rate base cap. We note that DRA has no objections to the SCADA system and security equipment San Gabriel expects to install.
The Fontana Division currently has two emergency interconnections, with a total capacity of 2,500 gpm, with the Cucamonga Valley Water District (CVWD) to provide water during emergencies and water system outages, but the ability to use these interconnections is limited. The Master Plan recommends installing a replacement 10,000 gpm interconnection to maximize deliveries during emergencies. San Gabriel explained that an improved emergency interconnection with CVWD will provide an alternative source of water to the elevated Hunters Ridge portion of the service area, and will help meet potential fire fighting demands during emergencies that may cause shortages in other sections of the Company's water system. San Gabriel has arranged for CVWD to design a 10,000 gpm connection and has budgeted $2.2 million in 2007 for installing 8,800 feet of pipe and a booster station to deliver water from CVWD. DRA reluctantly considered a $2.2 million investment in the CVWD emergency interconnection to be reasonable, and included it as a rate base addition. DRA's concern is that the connection cannot be relied upon during peak summer days when CVWD's demand also peaks. We do not share DRA's concern. The connection is not expected to meet peak demand, but to meet emergency demands on San Gabriel's system.
San Gabriel has planned the construction of a new office/warehouse for its Fontana operations. DRA toured the current facilities which will be replaced by the new complex and agrees that a new facility will provide a more conducive work environment. DRA is concerned about the acquisition of the property. First, San Gabriel acquired the property for the new facility on December 30, 2004 for $1,102,233 from Rosemead Properties, Inc. (Rosemead), an affiliate company of San Gabriel. The acquired parcel was part of an 8.72 acre parcel originally acquired by Rosemead on July 8, 2003 for $1,075,000. DRA recommends that the cost of the land acquired for the office building be reduced based on the cost paid by San Gabriel's affiliate Rosemead.
San Gabriel's witness calculated the purchase price of the property for Rosemead to be $126,000 per acre and the price to San Gabriel for the property to be approximately $234,000 per acre. The witness testified that an independent appraisal showed the property appreciated that much in a year and a half. He testified that Rosemead bought the land to hold for investment, and that San Gabriel purchased the land from Rosemead because the land suited San Gabriel's needs. He said that San Gabriel's personnel went through a long process to determine whether the Rosemead property was a site that made sense for San Gabriel's offices. Rosemead cooperated with San Gabriel in ways that a third-party seller would not have done, selling San Gabriel the exact amount of land needed for its facilities and in the configuration San Gabriel required.
We will allow $591,250 in rate base calculated on the ratio of the size of the parcel Rosemead sold to San Gabriel to the size of the larger parcel of which it was a part. The parcel size and cost are not crystal clear on the record, but the evidence persuades us that the parcel San Gabriel purchased was 4.81 acres (San Gabriel O.B. p. 85); the Rosemead purchase was 8.72 acres (Ex. 23); the Rosemead price was $1,075,000. (Tr. p. 282, L.5.) We find that San Gabriel should have been charged 55% of $1,075,000, or $591,250 for the land.
This violation of the affiliate transaction restriction is particularly egregious. Rosemead is owned by United Resources, Inc. (United Resources). United Resources also owns San Gabriel. Rosemead purchased the property during the time that San Gabriel was seeking land on which to construct a new office building. The land was expected to go into rate base. When the land was sold by Rosemead to San Gabriel in December of 2004 it occurred during a process characterized by San Gabriel's vice president:
"Q. Well, there wasn't really any negotiation, was there?
"A. Well, it's essentially the same parties, so there's not negotiation per se, but the - well, no, there was not negotiation." (R.T. 284, L 22-26.)
The purchase agreement on the part of the seller was signed by R. H. Nicholson, Jr., the President of Rosemead and the Chairman of the Board of San Gabriel. The purchase agreement on the part of the buyer was signed by Mike Whitehead, President of San Gabriel. Mr. Whitehead reports to Mr. Nicholson.
San Gabriel estimates that cost to construct the new facility will be $6,000,000 and that the cost be included in rates through an advice letter. DRA disagrees.
The proposed new office complex of 40,658 square feet is approximately twice the size of the facilities (20,827 square feet) it is designed to replace. San Gabriel maintains that it still needs to retain a building on the existing site for a satellite customer service office. The new office complex includes approximately 11,548 square feet of office space for employees that previously occupied 4,719 square feet of space.
In its last rate case, A.02-11-044, San Gabriel first requested $3 million for the construction of a new office, and later during the proceeding increased to $6 million. The Commission deferred the request to this GRC filing. The decision stated that if the Company were to request authorization to proceed with the new building, it should provide complete justification for the building and it should address the ratemaking treatment of the proceeds from the sale of the existing facilities. (D.04-07-034, p. 40.) DRA contends the Company has not addressed the ratemaking treatment for the existing facilities as ordered or even committed to disposing of the existing facilities.
DRA argues that the proposed facility is excessive when compared to the facilities to be replaced; the $6 million request exceeds the $4.9 million cost to refurbish the existing facilities; the Company has not provided any justification for the cost of the new office/warehouse; nor has it addressed the ratemaking treatment for the existing facilities or committed to their dispositions.
DRA recommends that 50% of the proposed cost of $6 million be phased into CWIP during the years 2006 and 2007. San Gabriel should also be required to dispose of the facilities that are to be replaced via an arms-length transaction to an unrelated third-party, with the benefit of the sale going to ratepayers. For ratemaking purposes, the recommended amount for the new facility should remain in CWIP to allow the Company an opportunity to earn a return on the cost of the portion of the facility that may be found to be used and useful. In its next rate case, costs should be reviewed for prudence and the facility's size evaluated to determine whether the entire facility is used and useful. All gains derived from the sale of the existing facilities should be returned to ratepayers by offsetting the cost of the new facilities.
While we do not doubt that more office space is needed by San Gabriel, it has not convinced us that its proposed size is reasonable. We will authorize San Gabriel to phase in up to $4.9 million, the cost of refurbishing the existing facility, in CWIP during the years 2006 and 2007. For ratemaking purposes, this amount should remain in CWIP to allow the Company an opportunity to earn a return on the cost of the portion of the facility that may be found used and useful. In its next rate case, costs should be reviewed for prudence and the facility's size evaluated to determine whether the entire facility is used and useful. Should the final amount of the new facility placed into rates exceed that amount for which CWIP was allowed, the balance plus an allowance for funds used during construction should be placed into ratebase.
We are also concerned about the disposition (or lack thereof) of the existing facilities. San Gabriel shall remove from ratebase the existing HQ facilities except half of the land where Plant F-25 is located. A sale of any portion of this would be a sale under Section 790. San Gabriel shall reinvest these funds within the time frame required or shall be required to return 100% of the unreinvested proceeds to ratepayers. We note that the increase in ratebase caused by the construction of the new facilities is offset, at least in part by the reduction in rate the existing facilities.
We caution San Gabriel that we are concerned that the transfer of this property to an affiliate will raise significant concerns about the valuation of the property. We would prefer that any sale be an arms length transaction with a third party. Further we note that a transfer from one affiliate to another may not constitute a sale under the meaning of Section 790. Under the 10% cap we need not allocate construction costs.
CWIP is reflected in rate base (for water companies) as a means of allowing the utility to recover the financial carrying cost of investments in capital projects before they go into service. In the present circumstances, the Fontana Division's recent year-end CWIP balance is higher than normal, due to major projects the Company has under construction. The Company utilized the CWIP balance as of December 31, 2004 in each rate year. The December balance was higher than the historical CWIP balance because of the major projects currently being developed, which included the Sandhill plant modification, the new office complex, and the SCADA system. DRA points out that each of the projects included in CWIP are projects the Company has included in its requested plant additions. DRA believes inclusion of the cost in CWIP and in plant represents a double count of a portion of the requested plant costs.
The Company has estimated $7.7 million for CWIP for TY 2006-2007 and the same for TY 2007-2008. DRA has estimated an average of $5.5 million for TY 2006-2007 and $6.6 million for TY 2007-2008. (Ex. 45, 8-24, 25.)
The rate base cap of 10% includes plant in service plus CWIP. The capital budgets on which San Gabriel based its calculations of plant additions reflect only amounts to be spent in calendar years since 2004, the year upon which current rates are determined. We would expect a higher CWIP for TY 2006-2007 because of the major projects under construction. We find that the Company's CWIP is probably low, but reasonable. There is no double count.
San Gabriel determined its projected material and supplies by calculating a five-year average of historical materials and supplies in 2004 dollars. The Company then increased the average for the percentage increase in plant projected and the non-labor inflation rate. DRA disagrees with San Gabriel's calculated projection because the application of the growth rate in plant is not justified. The average plant balance increased approximately 10% in 2004, but the average materials and supplies decreased by approximately 16%. The average plant balance in 2003 was approximately 11% higher than 2002, and the average materials and supplies for 2003 was approximately 3% higher than 2002. DRA asserts San Gabriel's growth factor is not justified. (Ex. 45, p. 10-3.)
DRA recommends that the five-year materials and supplies balance be adjusted for inflation only, using the updated inflation factors previously discussed. DRA's recommendation results in a reduction to materials and supplies included in rate base of $238,300 in TY 2006-2007 and $326,200 in escalation year 2007-2008. (Ex. 45, pp. 10-3 - 10-4). The resulting materials and supplies balance to be included in rate base is $766,300 in TY 2007-2008 (Ex. 45, pp. 10-7 and 10-8).
San Gabriel disagreed with DRA's position, discounting DRA's emphasis on variations over a single year. San Gabriel emphasized that the materials and supplies balance increased by 56% over the last five recorded years, while utility plant increased by 48%, demonstrating a strong relationship between the rate base balances for utility plant and materials and supplies. We find reasonable San Gabriel's forecast method for materials and supplies, reflecting plant growth as well as general inflation (using updated inflation factors).
San Gabriel reflected in its plant balance the same amount of advances for construction that is being reflected in the projected advance credit balance that offsets rate base. The additions to the advance account for the past five years averaged $3 million. The additions projected for 2005-2008 average $2 million. DRA accepts San Gabriel's estimate, but comments that the Master Plan attributed the additional plant requirements to growth in the Fontana Division. The growth that creates the need for additional plant should be either advanced or contributed by developers. We agree with DRA's comment. As with CWIP, we find the Company's advance estimate is low, but reasonable.
San Gabriel reflected the same amount of contributions that are being reflected in the projected contributions credit balance that offsets rate base. The additions to the contributions in aid construction for the past five years averaged $1.3 million. The Company's additions projected for 2005-2008 average $850,000. Historically, the $1.3 million represented approximately 11% of the $11.677 million average of gross plant additions. The projected $850,000 average for contributions is approximately 5% of the $18.379 million average plant additions estimated for the years 2005-2008. The difference between the actual and the estimates suggests that San Gabriel understated the projected contributions. We will adopt the historical average for contributions of $1.3 million. We do not understand how San Gabriel can project above average increases in plant while predicting a lower rate of CIAC. It appears the Company is maximizing its investment, which earns a return, rather than seeking contributions, which do not.
There are two main elements to the calculation of a working cash allowance: an operational cash requirements and a lead-lag study. San Gabriel's witness testified that San Gabriel prepared the working cash component of rate base consistent with the method used by the Commission in prior rate cases. The witness explained that San Gabriel's method complies with the detailed basis for computing revenue lag and expense lead/lag as stated in the Commission's Standard Practice U-16. He summarized the minimum balances comprising the operational cash requirement.
DRA objected to several aspects of the Company's working cash calculations. DRA claimed to find an understatement in San Gabriel's lead-lag study of the lag for power costs. Reviewing San Gabriel's bills from Southern California Edison Company (SCE), DRA used a weighted average payment lag of 33.8 days as compared to 19 days used by the Company. DRA also criticized San Gabriel for ignoring working cash on hand not supplied by shareholders, including taxes collected for advances and contributions, advances not yet reflected as rate base offsets, and pending refunds. DRA contends that these adjustments justified a $6,595,574 reduction in San Gabriel's working cash - producing a negative working cash allowance of ($5,717,074).
Standard Practice U-16 does not mandate a single methodology for calculating working cash. Rather, it "serves a guide to the staff engineer or analyst" based on current staff practices that the engineer or analyst should consider in determining the working cash allowance. Standard Practice U-16, Paragraph 8 under Section D - Working Cash Component of Rate Base states, "for practical reasons, the method of determining the working cash allowance varies with the size, nature, and the operation of the utility."
Regarding the lag days for power costs, San Gabriel's witness explained SCE issues one monthly invoice to San Gabriel for facilities that are read on many different meter reading cycles. San Gabriel is billed and makes payment on a single 30-day billing cycle, to which the Company's 19-day lag calculation applies. He said San Gabriel calculated the operational cash requirement by a simplifying convention consistent with the purpose of the working cash allowance and approved in past GRCs, including minimal cash balances required to be maintained in its customer service office cash drawers, petty cash, minimal balances in its regular checking and return checking bank accounts, and one-half of its postage account maintained at the post office. The total of these items is $26,000.
Responding to DRA's assertion that San Gabriel's working cash calculation ignores non-investor supplied cash, he explained that Standard Practice U-16 provides for calculating an operational cash requirement as well as deductions from the operational cash requirement, and that it would be consistent with the Standard Practice U-16 to combine the operational cash requirement from which those deductions are taken. The witness testified that DRA's results "grossly understate the operational cash requirement."
We agree with San Gabriel's working cash estimate. It was done in accordance with Standard Practice U-16. DRA has completely misconstrued Standard Practice U-16; DRA has ignored the operational cash requirement. Negative working cash in the millions of dollars makes no sense. We have discussed this in detail in our recent discussion (D.06-06-036) in the rehearing of D.05-08-041 in A.02-11-044. San Gabriel's estimate is adopted.
San Gabriel's depreciation reserve, accruals, and expense for recorded years 2000 through 2004, estimated year 2005, and TYs 2006-2007 and 2007-2008 were accepted by DRA subject to differences regarding estimates of utility plant in service and advances during the relevant years, and subject to correction of a mathematical error in San Gabriel's calculation of net plant retirements. We adopt the same methodology in determining the depreciation expense based upon our adopted estimates of utility plant.
X. Cost of Capital
The cost of capital for a public utility typically is expressed as an overall rate of return, calculated by adding the weighted costs of long-term debt, preferred stock, and common stock equity. Because San Gabriel has no preferred stock outstanding, its capital structure includes only the two factors of long-term debt and common equity. During the evidentiary hearings, San Gabriel and DRA achieved a stipulation as to the capital structure, cost of debt, return on equity (ROE) and overall rate of return for purposes of this GRC, agreeing on an ROE of 9.90%, and overall rate of return of 9.33% for TY 2006-2007 and 9.35% for TY 2007-2008. Neither the City nor the District joined the stipulation.
DRA's expert witness proposed an imputed capital structure consisting of 40% long-term debt and 60% common equity, an equity ratio approximately half way between the average equity ratio of a group of small water utilities and San Gabriel's actual equity ratio. This was accepted by San Gabriel. The City's expert witness recommended an imputed capital structure consisting of 50% debt and 50% equity, based on a proxy group of water utilities which had a five year average debt/equity ratio of approximately 50/50. We have addressed this issue in the last two GRC decisions for San Gabriel, D.04-07-034 in the last Fontana Division case and D.05-07-044 in last year's Los Angeles County Division GRC. In both decisions, we adopted a hypothetical capital ratio of 60% common stock equity and 40% long-term debt. Having adopted a 60/40 ratio in 2004 and 2005, we are disinclined to depart from that ratio absent compelling evidence. We adopt the stipulation between San Gabriel and DRA.
The stipulation between the DRA and San Gabriel results in a cost of long-term debt for each year, 2006 through 2008, based on the amounts proposed by San Gabriel. The agreed upon long-term debt rates are: 8.44% for 2006, 8.49% for 2007, and 8.54% for 2008. The City's expert recommended using San Gabriel's historical issuance cost of debt, calculating overall interest costs of 8.33% to 8.36%. He adjusted downward the estimated issuance expenses on San Gabriel's planned debt issues. We are not convinced bond costs will be as low as the City's witness has estimated. We adopt San Gabriel and DRA's stipulated amounts.
Equity cost is a direct measure of the utility's after-tax ROE investment. Its determination is based on subjective measurement, and is not susceptible to direct measurement in the same way as capital structure and embedded long-term debt costs. The quantitative models commonly used as a starting point to estimate investors' expectations are the discounted cash flow (DCF) and risk premium (RP). Although the parties agree that the models are objective, the results are dependent on subjective inputs. For example, each party used different proxy groups, growth rates, and calculations of market returns. Detailed description of the DCF and RP models are contained in the record and are not repeated here.
San Gabriel's expert witness presented an analysis of its cost of equity financing developed from a range of estimated equity costs for a sample of water utilities and gas utilities. The range of estimated equity costs resulting from the water utilities sample was from 10.3% to 11.6%, while the overall range of estimated equity costs for San Gabriel was from 11.5% to 12.8%, supporting a recommended 12.0% ROE. San Gabriel's own recommendation was an ROE of 11.5%. DRA originally proposed an ROE of 9.0%, while the City proposed an ROE of 8.9%. San Gabriel and DRA agreed to jointly support an ROE of 9.9%. Consistent with a 9.9% ROE, San Gabriel and DRA also jointly proposed to set the overall rate of return for TY 2006-2007 at 9.33% and for TY 2007-2008 at 9.35%.
DRA's expert witness criticized the 11.5% ROE as unreasonably high due to the use of forecast interest rates above current long-term yields, and excessive risk premium estimates. The City's expert witness expressed similar objections. Both witnesses criticized the relevance of San Gabriel's consideration of a sample of natural gas utilities.
What stands out in a comparison of the testimony of the experts is the inevitable and pervasive use of judgment, which colors all results. We have recently reviewed ROE for San Gabriel in its recent rate cases and found reasonable in 2004, an ROE of 10.10% (D.04-07-034, p. 59); and again in 2005 an ROE of 10.10% (D.05-07-044, p. 33). In this case, San Gabriel and DRA have stipulated to an ROE of 9.90%, the City proposes 9.0%. Having recently considered this matter, we believe a 20-basis point reduction in ROE is more in line with current trends than the City's more drastic 120-basis point reduction. We adopt 9.90% as the reasonable ROE and the overall rates of return of 9.33 for TY 2006-2007 and 9.35% for TY 2007-2008 as stipulated by DRA and San Gabriel (Ex. 85).
XI. Revenue Recovery Issues
San Gabriel seeks to phase into rates by advice letter filings the capital costs for its planned new headquarters complex ($3 million in the 2005 capital budget and $3 million in the 2006 capital budget) and for the post-2005 portion of the Sandhill plant upgrade project ($18 million in 2006 and $4 million in 2007). San Gabriel believes that advice letter treatment will temper the rate impact on customers by implementing necessary rate increases in smaller increments. While rate changes for the test year and escalation years are intended to be effective as of July 1, San Gabriel proposes to schedule rate increases related to these advice letter projects for January 1 of each year, when water usage tends to be lower than in the summer.
San Gabriel proposes to include the $12 million budgeted for expenditure in 2005 for the Sandhill upgrade project in TY 2006-2007 rate base, but to track other capital expenditures on Sandhill and the headquarters complex, adding an allowance for funds used during construction (AFUDC) or interest during construction (IDC) if not reflected in test year CWIP. It would submit advice letters by November 15 of each year to effect rate increases on the following January 1 reflecting inclusion of those investment and interest amounts in rate base.
DRA recommends that the cost of the Sandhill plant upgrade be removed from plant in service, and that the proposed advice letter treatment for the incremental costs be disallowed. It argues the next GRC is the proper time to make a determination of whether the cost of the upgrade is appropriate, since by that time the new plant should be operational and its capacity can be readily determined. The Company can accumulate charges for IDC so that its investment is protected until such time as a final determination on the project can be made.
We disagree with DRA. We have found that the plant is needed and have established a cap of $35 million for construction costs. We will allow San Gabriel to place its completed portions into ratebase by advice letter. San Gabriel may file an advice letter by November 15th to be effective January 1st of the following year to place its investment in the Sandhill facility into ratebase.
Similarly, the request to use an advice letter filing for the headquarters complex is denied. However, the company may use the advice letter process to increase its CWIP as a result of investment in its new headquarters building. San Gabriel may file an advice letter by November 15th to be effective January 1st of the following year to place increases to CWIP associated with its New Headquarters building.
However, DRA recommends that San Gabriel be allowed recovery via advice letter of the new Water Treatment Operator III positions after the Sandhill water treatment plant upgrade is in service and the positions are actually filled by San Gabriel. As we discussed earlier in this opinion, those Water Treatment Operator III positions will have to be filled well in advance of the Sandhill upgrades being placed in service, so the new employees can be trained and become familiar with the plant as built. DRA's proposal to use the advice letter process to cover the expense associated with these positions after the Sandhill plant upgrades are placed in service is denied.
Early in 2002, in response to the loss of regular service from seven wells that were contaminated with perchlorate, San Gabriel realized the Fontana Division was facing an increase in water quality litigation costs. San Gabriel responded by opening a Water Quality Litigation Memorandum Account in March 2002 to record outside legal expense related to water quality litigation for the Fontana Division. By D.04-07-034, we authorized a 12-month amortization of the July 2003 balance of $1.0 million, which was completed in July 2005. San Gabriel seeks to amortize the balance recorded in the Water Quality Litigation Memorandum Account as of June 30, 2006. In October 2005, the account balance stood at over $2 million.
DRA agrees that water quality litigation costs should continue to be subject to a memorandum account and the expenses associated with water quality litigation should be excluded from base rates. DRA, however, takes issue with the timing of the amortization of the costs contained in the account. DRA recommends that recovery of the costs be deferred until the amount of recovery from third parties can be determined. DRA says it is obvious the Company anticipates that the costs of water quality litigation will result in significant recoveries, which are anticipated to exceed the costs incurred. Therefore, it is wrong to charge current ratepayers with the costs by annually amortizing the memorandum account in rates when it is the future ratepayers who will receive the benefit of the costs. DRA recommends that these expenditures be deferred to be matched up with the future benefits. The Company is not harmed by the deferral as the memorandum account accumulates interest.
San Gabriel objects to deferral of cost recovery. It argues that water quality litigation has become an ongoing Company responsibility with no end in sight. Since San Gabriel is the plaintiff in pursuing the polluters, there is no prospect of recovering its litigation expenses from the Company's insurers. Meanwhile, interest accrues on unrecovered litigation costs. Just as the Commission has urged water utilities to actively pursue the polluters, the Commission should set rates that allow recovery of the costs incurred in that process on a current or near-current basis. Allowing relatively current recovery of accrued litigation costs will not prevent ratepayers from fully benefiting from all recoveries and certainly will not diminish the Company's incentive to seek recoveries from polluters.
We agree that a prompt amortization of the June 30, 2006 balance in the account is appropriate. The lawsuits are for current damages to wells that are, or were, in service for current customers. We believe San Gabriel is actively pursuing polluters and prompt amortization of legal costs will encourage continued pursuit. However, the record is not clear regarding the details of this account. Therefore, we will require the Company to file a new advice letter to be approved by the Water Division. The advice letter shall include a detailed description of the service provided. The amount approved shall be recovered by surcharge.
DRA recommends that San Gabriel be allowed to continue to maintain a WQMA, so that amounts received from polluters or grants received from government agencies may benefit future ratepayers. The WQMA was established in the last GRC, with the intention that any funds received in the future from lawsuits against polluters and from grants would be included in that account and ultimately invested in remediation efforts in a way that would shield ratepayers from bearing the costs to the extent such funds were available. Some settlements have been treated as contributions toward the capital cost of facilities, thereby reducing rate base.
This account is a benefit to ratepayers. But it is only a benefit to the extent that San Gabriel accurately accounts for funds received. Our discussion of the use of such funds, set forth below, causes us great concern. Funds have been diverted from benefiting ratepayers to benefiting shareholders.
A key element in calculating revenue requirement is the net-to-gross multiplier, a factor applied to the forecast net income to calculate tax consequences of the required test year and attrition year revenue requirement. San Gabriel's proposed net to-gross multiplier is 1.800324. DRA proposed 1.77286 as the net-to-gross multiplier, the difference being DRA's use of an uncollectibles rate of 0.1951% and a deduction for qualified production activities under the Jobs Act, both items discussed above. We find the net-to-gross multiplier to be 1.772805 based on the resolution of those issues.
In accordance with the RCP, year 2007-2008 is a test year for items related to rate base and an escalation year for all other revenue requirement components, and TY 2008-2009 is an attrition year for rate base items and an escalation year for other components. We have followed the RCP requirement for test year, escalation, and attrition factors to produce revenue requirement and rate increase calculations for escalation years 2007-2008 and 2008-2009.
XII. Rate Design
The City proposes that the Commission require San Gabriel to impose a facilities fee for new development receiving water service from the Fontana Division. Growth is forecasted to be approximately 1,350 new connections each year. Other water purveyors in the region charge between $5,000 and $7,000 per new home connected to the system and use those funds to pay for additional capacity needed to serve new customers. The City provided Exhibit 54, a "Capital Development Fee Survey," which calculates an average cost of development fees and the range of such fees for various meter sizes as such fees are assessed by a set of nine public water districts or cities in general proximity to the City of Fontana. DRA takes the position that to the extent any addition to plant is growth related, the cost of the added facilities to serve such growth should be contributed by the developer.
A witness for the City testified that all his current public agency clients assess facility charges in the range of $5,000 to $7,000 on developers to pay for upgrades to accommodate future growth. San Gabriel's witness agreed that this was a common practice for public entities financing infrastructure to serve new developments, and considered this an advantage for public water districts or cities in contrast to Commission-regulated water companies.
A major consideration with respect to potential facilities fees, development fees, connection fees, and the like, was whether the proceeds would be subject to federal income tax. It is important to describe such a fee in a manner to avoid the payment of taxes. San Gabriel's expert explained that Section 118 of the Internal Revenue Code (IRC) makes advances for construction and CIAC non-taxable for water utilities, while defining CIAC to exclude "amounts paid as service charges for starting or stopping services." He concluded that it would be feasible to implement a non-taxable facilities fee in compliance with a Commission tariff requiring developers or customers to pay for utility plant other than costs to install service connections. Pending the collection of facilities fees, he recommended that the Commission authorize San Gabriel either to include construction costs in rate base as CWIP or to add AFUDC or IDC to the cost of those facilities, which ultimately would be offset in ratemaking by the collection of the facilities fees that could be recorded as CIAC. By connecting the facilities fee to specific projects required for growth, it would be clear that such a fee is not tied to the cost of installing a service line or a charge for connecting to the system or starting service. He did not estimate the amount of the facilities fee or the amount of rate base reduction that could result.
San Gabriel and DRA each submitted late-filed exhibits presenting calculations of the effects of a facilities fee of $5,000 per new connection on San Gabriel's rate base and revenue requirement. San Gabriel recommends that facilities fee receipts through September of each year be recognized as deductions from rate base in conjunction with annual advice letter filings phasing Sandhill upgrade and headquarter complex investments into rates effective January 1 of the following year. Thus, if 1,350 new connections actually are added per year and a $5,000 fee per connection charged during this three-year rate case cycle, over $20 million of facilities fees would be collected from developers resulting in an eventual $4 million per year ratepayer revenue savings.
DRA presented an exhibit with somewhat different calculations of the impacts of $5,000 facilities fee, with estimated ratepayer savings up to $3.20 million per year.
San Gabriel does not oppose adoption of a facilities fee payable by developers or new customers, but San Gabriel is concerned about a number of key issues, which include:
· Given the uncertainty and volatility of real estate development, the revenue that a facilities fee would generate is highly uncertain both in amount and timing. In order to avoid burdening San Gabriel with a new and incremental source of financial risk, it is essential that facilities fee revenues only be taken into account for ratemaking purposes once they have been received, through an advice letter.
· Given the intention of treating facilities fee revenues as CIAC, offsetting additions to utility plant and thereby avoiding increases in rate base, it is important to identify capital projects that are needed, in whole or in part, to serve new customers rather than existing system requirements.
· While it appears to have been assumed that "developers" would be responsible for paying the facilities fee, the existing evidentiary record does not provide a working definition of that term and does not provide a basis for determining what percentage of new service connections are for properties constructed by a "developer," however that term may be defined, or for determining whether a facilities fee would apply with respect to new service connections not involving a "developer."
DRA, the City, and the District all recommend a more direct application of the facilities fee. They point out that San Gabriel has presented the facilities fees as offsets to its proposed future advice letters for the Sandhill plant and the office complex, and not as a CIAC offset to rate base. DRA asserts that the impact, if the facilities fees are adopted, should be shown as an offset to rate base in the test year and each of the escalation years, and not as offsets to proposed future advice letters. DRA disagrees with San Gabriel's proposed advice letter treatment for both the Sandhill plant upgrade and office complex. As shown on Joint Exhibit 62a, DRA's proposal would reduce San Gabriel's revenue requirement by $637,815 in TY 2006-2007; $1,902,612 in escalation year 2007-2008 and $3,137,472 in escalation year 2008-2009.
A facilities fee of a maximum $5,000 for a 5/8" x 3/4" meter is reasonable and will be authorized. San Gabriel has presented persuasive evidence that its customer base is growing by about 2 ½% per year with concomitant growth in water usage. It proposes upgrades to its Sandhill plant, new wells, new reservoirs, and equipment to meet this growth. It is not unreasonable to require new customers to assist in paying for these new facilities through a facilities fee paid prior to connection. The City strongly supports this fee and has submitted a resolution of the City Council affirming its support. The water systems closest to San Gabriel have imposed facilities fees in varying amounts depending on meter size.
Table 1 | ||
Water Purveyor |
Meter Size/Fee | |
3/4" |
1" | |
City of Chino |
$5,809 |
$5,809 |
City of Ontario |
$5,147 |
$5,147 |
City of Rialto |
$5,100 |
$8,500 |
West Valley Water District |
$5,080 |
$8,635 |
City of San Bernardino |
$6,375 |
$8,445 |
City of Upland |
$ 600 |
N/A |
Cucamonga Valley Water District |
$2,864 |
$4,783 |
City of Colton |
N/A |
$2,900 |
Monte Vista Water Company |
$3,429 |
$5,486 |
Average Cost |
$4,300 |
$6,213 |
Based on charges of similarly situated water purveyors we find a facilities fee of $5000 per new service connection up to 3/4" meter size to pay for the cost of new infrastructure is reasonable. Higher meter sizes will pay according to the following ratios, as proposed by the Commission's Water Division:
Table 2 | |
Facilities Fee Allocation By Meter Size | |
Meter Size |
Ratio |
5/8" x 3/4" or 3/4" |
1.0 |
1" |
1.33 |
1- 1/2" |
2.0 |
2" |
2.67 |
3" |
4.0 |
4" |
5.33 |
6" |
8.0 |
8" |
10.67 |
10" |
13.33 |
12" |
16.0 |
14" |
18.67 |
We agree with San Gabriel that the revenue the facilities fee will generate is highly uncertain in both amount and timing, given the uncertainty and volatility of real estate development. Therefore, we adopt the following procedure:
1. All fees collected must be kept in a separate interest bearing bank account and be recorded in a memorandum account. They shall be credited to CIAC at the time the fees are spent for additional plant.
2. The utility shall show the balances in its annual report to the Commission. Fund balances should be listed as debits to Account 132, and as credits to Account 253, other credits.
3. Interest should also be debited to Account 132, and credited to Account 421, non-utility income.
4. When plant is replaced using funds from these fees, a debit should be made to the appropriate plant account and a credit made to Account 271, CIAC.
5. The fee is applicable to all customers applying for service from the utility in the territory served for premises not previously connected to its distribution mains, for additional service connections to existing premises, and for increases in size of service connections to existing premises due to change in use.
See Appendix D for a form of tariff.
Since the mid-1980s, a City ordinance has mandated fire sprinklers in all new residential construction. One-inch water meters are required in conjunction with such sprinkler systems and, therefore, owners of newer homes in Fontana consequently pay higher monthly service fees than other residential customers. The City proposes to equalize the service charge for a 3/4" meter and a 1" meter. San Gabriel's witness opposed this proposal and explained that the higher service charge for a one-inch meter follows Commission guidelines established by D.86-05-064; imposing additional charges on other Fontana Division customers would subsidize new home owners who are subject to the City's fire sprinkler ordinance. To modify the service charge to equalize it for new residences would be a change which would benefit occupants of recently constructed homes at the expense of customers with older residences. Such a rate design change would run directly counter to the City's other rate design proposal, a facilities fee.
DRA has reviewed San Gabriel's monthly service charge and finds that it is in compliance with the Commission's Water Rate Design Policy set forth in D.86-05-064. This method is based on 50% of fixed costs being included in the service charge, with remaining costs recovered through a single block commodity charge. DRA takes no issue with the methodology used by the Company. It is adopted.
In San Gabriel's last rate case, D.04-07-034, the Commission required San Gabriel to implement a low income rate program. Under CARW qualifying customers receive a 50% reduction to their monthly service charge. Within the rate design calculations presented by San Gabriel, the Company has assumed that 30.7% of the Fontana Division's residential customers served through a 1-inch or smaller meter will qualify for the CARW program. That impact is spread over all remaining service calculations. DRA takes no issue with the Company's assumptions and calculations regarding this program. It is adopted.
Further, San Gabriel shall continue to record the costs of its CARW in its memorandum account. San Gabriel shall also report to the Director of the Water Division annually the amount of annual costs of the CARW program and its impact on rates.
San Gabriel, may file by advice letter for authority to recover the costs of the CARW through a surcharge and removing the costs from rates. Such an advice letter should be filed 90 days prior to the desired effective date.
XIII. Water Division Audit Report
San Gabriel has two divisions: the Fontana Division and the Los Angeles County Division. In the last Fontana Division rate case decision, D.04-07-034, we ordered our Water Division to audit, prior to Fontana Division's next general rate case, all sale and condemnation proceeds received by San Gabriel from 1996 onwards. Although D.04-07-034 only pertained to the Fontana Division, the proceeds at issue also included proceeds from the Los Angeles County Division. Additionally, in the last Fontana Division rate case, the City of Fontana raised the issue of whether proceeds received by San Gabriel from condemnation, service duplication, and lawsuit settlements related to water contamination had been properly accounted for. This was also part of the Audit Report.
The major findings of the Audit Report are summarized as follows:
· San Gabriel received $27,811,312 in gain from various transactions during the years 1996 to 2004 from:
Fontana |
Los Angeles |
Total | |
Water contamination (Non-CIAC) |
$ 8,559,863 |
$ 11,081,498 |
$ 19,641,361 |
Service duplication |
$ 2,314,538 |
$ 1,500,000 |
$ 3,814,538 |
Sale on condemnations |
$ 2,520,148 |
$ 709,373 |
$ 3,229,521 |
Sale to private property owners |
$ 507,199 |
$ 618,693 |
$ 1,125,892 |
Total |
$ 13,901,748 |
$ 13,909,564 |
$ 27,811,312 |
· San Gabriel claims that the $27,811,312 proceeds were reinvested in water plant infrastructure in accordance with Section 790.
· Most of the $27,811,312 proceeds do not qualify under Section 790.
· $27,456,307 in net proceeds should be allocated to ratepayers.
· If the Commission accepts San Gabriel's claim that the proceeds qualify under Section 790, San Gabriel did not reinvest the proceeds in Section 790 plant infrastructure.
· $40,855,200 in dividends was paid to shareholders during 1996 to 2004. San Gabriel would not have been able to pay these dividends without the $27,811,312 proceeds received during those years.
San Gabriel asserts that it has accounted properly for the proceeds of all the relevant transactions, has complied with all recordkeeping requirements of Section 790, and properly has reinvested the proceeds in utility plant on which it is entitled to earn its authorized rate of return. It says if the Commission determines that some portion of those transactions and proceeds are not governed by Section 790 or the gain on sale OIR decision (D.06-05-041), the disposition of proceeds should depend on the relative risks and burdens borne by shareholders and ratepayers.
In 1995, the California Legislature adopted the Water Utility Infrastructure Improvement Act to address the challenge facing California's investor-owned water utilities to invest in new infrastructure, plant, and facilities to comply with increasingly strict safe drinking water laws and regulations, to develop new and existing sources of supply, and to replace or upgrade existing infrastructure, plant, and facilities. Pub. Util. Code § 789.1(a)-(e).
In Phase II of Rulemaking (R.) 0409003, we are examining the regulatory treatment of gains that result from the disposition of property as a result of condemnation, sales under threat of condemnation, and proceeds from inverse condemnations. We will defer judgment on the regulatory treatment and the application of Section 789-790 to these proceeds to that proceeding.
We now turn to the Audit Report.
Overall, the Audit Report addresses $27,811,312 in proceeds San Gabriel received from four categories of transactions during the years 1996 to 2004 in both the Company's operating divisions. By far the largest portion of this total was proceeds from contamination claims not classified as CIAC - $8,559,863 in the Fontana Division and $11,081,498 in the Los Angeles County Division. In both instances, the contamination proceeds at issue were above the amounts reimbursed to the Company for the costs to design, build, and operate wellhead treatment facilities; all of those reimbursements were recorded as CIAC rate base adjustments (for capital) or used to reduce customer revenue requirements (for O&M expenses). Another $2,314,538 in Fontana Division and $1,500,000 in Los Angeles resulted from service duplication claims. Lesser totals resulted from sales in connection with condemnations and sales to private property owners, respectively.
The Audit Report claims that, contrary to San Gabriel's contention, most of the proceeds at issue did not qualify under Section 790 - that is, they were not the proceeds of sales of real property. To whatever extent the proceeds did qualify under Section 790, the Audit Report asserts that San Gabriel failed to reinvest those proceeds in accordance with the statutory requirements. The Audit Report recommends that all of the $27,811,312 in proceeds from the four classes of transactions except for $355,005 in retired plant - a total of $27,456,307 in net proceeds - plus an unspecified amount of interest should be allocated to ratepayers.
Noting that San Gabriel paid more than $40 million in dividends from 1996 to 2004, the Audit Report argued that San Gabriel could not have paid those dividends without the $27,811,312 in proceeds that were the focus of the staff audit. The dividend payments contradict San Gabriel's claim that those proceeds were reinvested in Section 790 plant. The Audit Report recommends that even if the proceeds qualify under Section 790, the net proceeds of $27,456,307 must be allocated to ratepayers.
2. Applicability of Gain on Sale
Rulemaking D.06-05-041 in R.04-09-003
On May 25, 2006, the Commission issued its opinion regarding allocation of gains on sale of utility assets. (D.06-05-041.) In that decision we adopted a process for allocating gains (and losses) on sale received by certain electric, gas, telecommunications, and water utilities when they sell utility land, assets such as buildings, or other tangible or intangible assets formerly used to serve utility customers. In D.06-05-041 we deferred the issue of gains resulting from condemnation, sales under threat of condemnation and inverse condemnation. That phase is currently underway and we defer determining this issue in this proceeding until we have articulated our broader policy.
In most cases, utility ratepayers should receive 100% of the gain from depreciable property such as buildings. Ratepayers and shareholders, however, will split the gain from non-depreciable property such as land and water rights. We said, though ratepayers bear most of the risk associated with such property, a 50% - 50% allocation is a fair and reasonable outcome, partly to compensate for some financial risk borne by the utility, and partly as an incentive to utility management to manage its assets wisely.
The decision provides interpretation of the Water Utility Infrastructure Act 1995, § 789 et seq. We found that the Legislature intended the Act to give water companies certainty on how to allocate gains on sale, and to limit Commission flexibility in allocating such gains. We said the statute does not limit our ability to impose record keeping requirements on the water companies to ensure they give notice of planned sales and of how they would invest proceeds from the sale of formerly used and useful utility property in new infrastructure, and we imposed such requirements. We also discussed the treatment of proceeds attributable to property purchased with funds that did not come from the water company, such as developer funds and contamination litigation proceeds.
We said "unless otherwise stated, we also intend the answers to the generic gain on sale questions to apply to water utilities." (D.06-05-041, p. 12.) And we concluded "that incidence of risk is the best determinant of how to allocate gains and losses on sales." (Id., p.26.) We found that the Uniform System of Accounts (USOA) accounting categories, while necessary to ensure that utilities maintain their books in a consistent manner, do not control gain on sale allocation. (Id., p. 41.) We reviewed the Infrastructure Act in great detail, but did not resolve all issues. We said contamination proceeds do not involve sales of real property, so the Infrastructure Act does not apply, nor are such proceeds gains on sale; such proceeds are outside the scope of that proceeding. (Id., p. 69.)
San Gabriel took a prominent role in commenting on condemnation gains and involuntary conversion gains. It referred to two types of condemnation for which it contends the utility should receive the proceeds. First, utilities routinely sell property as a result of condemnation or under the threat or imminence of condemnation by a city or other governmental agency. Second, water utilities may also receive proceeds from inverse condemnation under the "Service Duplication Law," Pub. Util. Code § 1501 et seq. Such condemnations occur when the government constructs water facilities that duplicate the facilities of a private water utility. Under § 1503, the private utility is entitled to compensation for the reduction in value of its property even where the government does not physically acquire the utility property. In both cases, San Gabriel contends the proceeds should be treated as sales proceeds, and the gain or loss passed to utility shareholders. San Gabriel claims such treatment is consistent with the USOA, generally accepted accounting principles (GAAP) and federal and California income tax rules.
San Gabriel seeks too much. We have consistently maintained that accounting provisions do not control the ratemaking policies which we may determine to be reasonable and necessary; nor are income tax rules controlling. We noted in D.06-05-041 that we had received a great deal of comment on the condemnation (including sale under threat of condemnation) issue; we found the issue requires further consideration. We deferred consideration of this issue to a second, narrowly focused phase of R.04-09-003 proceeding. (Id., p. 77.)
Conclusion of Law 24 is particularly pertinent to this GRC. "Any water utility property that a utility disposes of that does not meet the Infrastructure Act's three criteria - (1) that an asset be sold, (2) that it no longer be used and useful, and (3) that it be real property - shall be accounted for in accordance with our general 100% and 50% - 50% percentage allocations." (Id., p. 93.) We apply these criteria to the gains resulting from contamination.
When private parties seek to purchase easements or real property in connection with planned improvements, San Gabriel determines if the property is no longer necessary or useful to the company for public utility service. The 24 sales to private parties in the Fontana Division during years 1996 to 2004 mainly involved release of easements or rights of way with lines damaged, threatened, or rendered unusable or hazardous by grading and construction operations. The Water Division agrees these properties were no longer necessary or useful and that the $507,199 San Gabriel received from property sales to private owners is governed by Section 790. We, also, agree.
When a government agency informs San Gabriel that a public improvement project requires acquisition or condemnation of San Gabriel's property, San Gabriel's normal practice is to work out a reasonable settlement and a voluntary sale. San Gabriel documented the circumstances of all ten such transactions between San Gabriel and the City of Fontana, the City of Rialto, or Caltrans, (as well as a minor access agreement with the County of San Bernardino), that were entered into during the years 1996-2004.
We received a great deal of comment on the condemnation (including sale under threat of condemnation) issue in R.04-09-003, our Gain on Sale rulemaking. In D.06-05-041, we determined that the issue requires further consideration and, perhaps, briefing. We therefore defer consideration of this issue to a second, narrowly focused phase of that proceeding. That phase is currently underway and we defer determining these issues in this proceeding until we have articulated our broader policy in R.04-09-003.
California law treats a government agency's duplication of the service or facilities provided by a privately-owned water utility as a taking of the property of the private utility to the extent it renders the private utility's property useless, inoperative, or reduces its value, and provides for payment of just compensation. (Pub. Util. Code § 1501 et seq.) San Gabriel argues that in past cases, even if the public agency did not physically acquire any of the utility's property, the Commission has directed the utility to account for such payments as proceeds of a sale. San Gabriel Valley Water Co. v. Montebello (1978) 84 Cal. App.3d 757, and Re San Gabriel Valley Water Co., D.92112 (hereinafter Montebello).
The amount in controversy is $2,314,538. San Gabriel claims that these service duplication proceeds qualify under Section 790. DRA and the Audit Report conclude that the $2,314,538 does not qualify as Section 790 proceeds because it was not the result of the sale of real property. There was no real property sale between San Gabriel and the City of Fontana. The settlement agreement with the City did not provide for any transfer of title or interest of property or rights to the City. Instead, the settlement paid San Gabriel just compensation under inverse condemnation by service duplication under § 1501 et seq.
San Gabriel contends these proceeds are treated under the California Code of Civil Procedure and under state and federal tax laws as inverse condemnation damages and, pursuant to Pub. Util. Code § 1501, et seq., as an involuntary sale of property. San Gabriel reads the Montebello case as one in which the Commission instructed San Gabriel to account for the damage award proceeds in a service duplication case the same as the proceeds of a sale and allocating all gain to the Company, even though no physical property changed hands. San Gabriel asserts that it has consistently accounted for all compensation from condemnations, including inverse condemnations, in accordance with this Commission's directive, i.e., as a sale of real estate. Accordingly, irrespective of whether the service duplication damages judgment is classified as Section 790 proceeds, the Audit Report is wrong in concluding that the $2.3 million judgment the City of Fontana paid San Gabriel should be allocated to ratepayers or treated as CIAC.
We will also defer the determination of what to do with the proceeds resulting from inverse condemnations. This issue is before us in R.04-09-003 and we will defer judgment on how to deal with these types of condemnations to that proceeding.
On November 10, 1998, San Gabriel entered into a settlement with the County of San Bernardino (County) where the County agreed to pay San Gabriel compensation for damaging San Gabriel's property by contamination from the County's Mid-Valley Sanitary Landfill. San Gabriel reported that it received, for the period 1998 to 2004, $8,559,863 from the County. These proceeds are comprised of the following:
Compensation for damages from 3/1/97 to 12/31/99 $4,052,449
Costs to construct Plant F-10 remediation facilities 3,996,455
Delay in restoring Plant F-10 to full service 455,959
Additional damages (addendum agreement) 55,000
Total $8,559,863
In addition, the County promised to pay San Gabriel for the actual costs to operate and maintain the Plant F-10 facilities after they were completed. For the period May 2000 to December 2004, San Gabriel incurred $1,242,057 in actual operating and maintenance costs, and the County reimbursed the costs entirely. Those reimbursed expenses were recognized in the last Fontana GRC. Although they were included in test year expense estimates, they were offset by the inclusion of estimates for the reimbursed revenue, and therefore revenue neutral for ratemaking purposes.
Of the $8,599,863 proceeds received from the County, $4,107,449 ($4,052,449 plus $55,000) represented compensation for damages resulting from water contamination from the County's Mid-Valley landfill. San Gabriel reported no plant assets had to be retired because of the water contamination. San Gabriel, however, did not consider these proceeds as CIAC, and thus, recorded these proceeds into a miscellaneous surplus account.
San Gabriel documented through its job orders that it cost $2,618,291 to construct the treatment facilities for Plant F-10. The Water Division reviewed Plant F-10 construction work orders and determined that San Gabriel was correct. In the last Fontana GRC, D.04-07-034 classified the $2,618,291 as CIAC for ratemaking purposes, and accordingly reduced rate base by the same amount. Although, San Gabriel intends to continue classifying the $2,618,291 as CIAC for ratemaking purposes in the current Fontana GRC, the Water Division found that San Gabriel has not adjusted its accounting records to record the reimbursement as CIAC.
There is an excess of $1,834,123 ($3,996, 455 plus $455,959 received in settlement minus $2,618,291 costs) in proceeds earmarked for Plant F-10 treatment facilities, which San Gabriel received, but did not use for building Plant F-10 treatment facilities. San Gabriel claims that any excess proceeds were reinvested in Section 790 plant infrastructure.
Excluding $2,618,291 of costs to build Plant F-10 treatment facilities from $8,559,863, there is an excess of $5,941,572 that San Gabriel received in the settlement. San Gabriel claims to have reinvested all excess proceeds in Section 790 plant infrastructure.
The Audit Report states that San Gabriel deposited the water contamination proceeds into its general bank account and then commingled these proceeds with all other funds received by San Gabriel. San Gabriel did not set up a memorandum account to track the proceeds received against funds spent. The Water Division was not able to track the spending of the proceeds against funds spent because San Gabriel could not provide appropriate documentation of how it accounted for the funds, segregated them, or otherwise tracked the money. Even if the contamination proceeds qualified under Section 790, without a means of tracking the proceeds to the invested infrastructure by the use of a memorandum account, or by some other equivalent record-keeping system, the Water Division concludes that San Gabriel has not met its burden of showing that it complied with Section 790 by reinvesting the $8,599,863 water contamination proceeds in plant infrastructure. DRA, the City, and the District all support allocating the entire $8,559,863 to CIAC, with no deduction for litigation expenses or taxes.
San Gabriel not only disagreed with the demand that all contamination gains should be allocated to the ratepayers, but asserted that all gains should be allocated to the shareholders.
San Gabriel argues that water rights are real property under California law, and that the County effected a taking of San Gabriel's water rights by rendering them useless due to the contamination that resulted from the County's landfill operations. This amounts to an inverse condemnation and is no less a sale of real property within the meaning of Section 790 than was the assignment of groundwater contamination damage claims approved by the Commission as a Section 790 sale in the recent Southern California Water Company case concerning the Charnock Basin. (Re Southern California Water Company, D.04-07-031.) Therefore, San Gabriel claims the proceeds received from the settlement of its groundwater contamination claims against the County qualify as a sale of real property, and are subject to reinvestment in utility plant pursuant to Section 790.
San Gabriel's argument is without merit. Its contamination lawsuit was a claim for damages; the settlement damage payment was not a sale of real property nor did it result in a sale. Section 790 requires a sale by the utility: no sale, no Section 790 relief. In re Southern California Water Co. there was (1) a sale for $5.9 million to Culver City of water rights no longer useful because of contamination, and (2) a recovery of some $5 million from oil companies and others who had caused the contamination. We held (1) that the sale of water rights to Culver City was subject to Section 790 because there was an actual sale, water rights are considered real property, and the contamination rendered the water rights no longer necessary or useful; and (2) the $5 million in damages recovered from the polluters should be allocated 100% to the ratepayers. We reasoned that ratepayers had to pay increased rates because of the loss of groundwater and had to pay depreciation and a rate of return on facilities that were rendered useless by the contamination. (D.04-07-031, mimeo., p. 15.)
In the case before us there is not sale of water rights (or any other property). San Gabriel's ratepayers have paid maintenance, depreciation, and return on facilities made useless by the contamination. Following Southern California Water Co., we should award all the gain from damages received from contamination suits to the ratepayers, but we believe the better course is to allocate the net proceeds evenly between ratepayers and shareholders. We acknowledge that the property damaged was owned by the shareholders of the utility and they deserve compensation for the damages to this property. However we also acknowledge that ratepayers were also harmed by the damages to these utility properties and that they, too, should receive the benefits of these awards for damages. We also seek to create a strong incentive for the utility to aggressively pursue compensation for contamination and believe that allocating 50% of such damage awards or settlements to shareholders provides just such a strong incentive.
San Gabriel shall book the 50% of the proceeds of contamination to CIAC, resulting in a corresponding reduction in the rate base of the utility upon which it earns a return.
Section 851 provides, in relevant part:
No public utility...shall sell...any part of its...property necessary or useful in the performance of its duties to the public...without first having either secured an order [or] obtained a resolution from the commission authorizing it to do so....Every sale...made other than in accordance with the [order or] resolution from the commission authorizing it is void....Nothing in this section shall prevent the sale...by any public utility of property that is not necessary or useful in the performance of its duties to the public....
San Gabriel's position is that it is not required by Section 851 to obtain Commission approval for the various sales of real property, including facilities and easements, to government agencies by condemnation or under threat or imminence of condemnation or to private property owners, because in each case San Gabriel had acted pursuant to an engineering memorandum prepared by a San Gabriel engineer documenting the status of the property as "no longer necessary or useful to the company in the performance of its obligations as a public utility."
San Gabriel argues that once a government agency elects to condemn the utility's property, and adopts a resolution finding the agency's planned use more necessary than the utility's, the agency's finding of necessity is not rebuttable, and the only remaining issue normally will be the amount of compensation to be paid. Neither the Company nor the Commission has the ability or authority to prevent such an involuntary sale, and the condemning authority has no need to obtain the Commission's permission to take the utility's property. San Gabriel contends that neither the Audit Report nor any of the parties refuted San Gabriel's showing of the impracticality and futility of applying Section 851 to sales under threat of condemnation as if condemnation was not impending. The Commission should look realistically at these situations and understand that the Commission does not have the legal ability to stop or delay a direct or inverse condemnation action by invoking Section 851.
DRA reads Section 851 to mean that utilities must first gain Commission authorization before selling, leasing, or disposing of any of its property that is either necessary or useful in the performance of its duties to the public. Without such authorization, such transactions are void. DRA says it is unacceptable to classify a property as "no longer, necessary or useful" to satisfy Section 790 simply because it is being threatened by imminent condemnation. Many of the properties sold under threat of condemnation were necessary or useful up to the point of the condemnation proceeding. The very fact that San Gabriel received condemnation proceeds for this property reflects the reality that the property had value at the time of condemnation. Thus, DRA concludes that since San Gabriel sold properties that were still necessary or useful, San Gabriel should have complied with Section 851 prior to sale.
We need not decide whether or not the property sold under threat of condemnation was necessary or useful. No party is seeking to void the transactions. Section 851 is not applicable to this proceeding. It is the allocation of gain from the condemnations that concerns us.
San Gabriel deposited the sales proceeds in a general checking account and claims the proceeds were later reinvested in Section 790 plant infrastructure. San Gabriel, however, did not track these proceeds in a memorandum account. DRA contends that without a means of tracking the proceeds to the invested plant infrastructure by the use of a memorandum account, or by some other equivalent record keeping system, San Gabriel has not met its burden of showing that it complied with Section 790 when it reinvested in plant infrastructure the $507,199 gain from sales to private properly owners.
San Gabriel treated its condemnation proceeds as it did its property sale receipts by depositing them in a general checking account, and thus commingled them with other cash deposits not related to condemnations. The Water Division reviewed job cost sheets and work authorizations, journal entries, and general ledger postings which San Gabriel claimed would support its investments into plant infrastructure during 1996-2004. The job cost documents disclosed the amounts actually spent on these projects, but did not indicate the funding sources. Some of the projects commenced at a time before San Gabriel even received the proceeds. San Gabriel paid for these projects from its general checking account, where funds came from a variety of sources.
DRA contends that without a means of tracking the proceeds to the invested plant infrastructure by the use of a memorandum account, or by some other equivalent record keeping system, San Gabriel has not shown it has complied with Section 790 by reinvesting in plant infrastructure $2,520,148 of gain from condemnation proceeds.
DRA contends that even if the service duplication proceeds were Section 790 proceeds, San Gabriel deposited the $2,314,538 into its general bank account and commingled these proceeds with all other funds. San Gabriel claims that these proceeds were later reinvested in Section 790 plant infrastructure, but San Gabriel had not established a memorandum account to track proceeds received or funds spent. In DRA's opinion there is no proof the proceeds were set aside or otherwise segregated so that they could be properly tracked. Without a means of tracking the proceeds to the plant infrastructure by the use of a memorandum account, or by some other equivalent record keeping system, DRA concluded San Gabriel has not shown it has complied with Section 790 by reinvesting in plant infrastructure $2,314,538 of service duplication proceeds.
San Gabriel maintains that the $8,599,863 of water contamination proceeds are Section 790 proceeds, and claims to have reinvested those proceeds in Section 790 plant infrastructure. To support this, San Gabriel provided a list of completed job orders as evidence of its reinvestment in plant infrastructure in compliance with Section 790.
The Water Division reviewed the job orders, and noted that the dates of the orders ranged from 1996 to 2002, which corresponds to the time San Gabriel received the contamination proceeds. There were, however, no indications that any of the job orders were directly funded by the proceeds, nor were any of the job orders for contamination-related purposes. The job orders were primarily for general improvements: installation of equipment such as fire hydrants, valves, and piping.
San Gabriel does not deny that it commingled all proceeds from the four categories of gains, nor does it deny that it did not record the gains in memorandum accounts. But it strenuously asserts that every penny received was invested in plant, and it provided confirming documents.
We have reviewed San Gabriel's job orders and find that San Gabriel has clearly established that it has maintained detailed records sufficient to document its investment in utility plant of the net proceeds of property sales, contamination recovery, condemnations, and involuntary conversions. Absent guidance or orders from the Commission, San Gabriel provided what it considered appropriate to comply with Section 790. Therefore, to the extent Section 790 is applicable to the proceeds at issue, San Gabriel has reinvested those proceeds in water system infrastructure necessary or useful in performance of its duties to the public, and those proceeds should remain in San Gabriel's rate base.
The proceeds of all four classes of transactions were deposited in San Gabriel's general bank account, and invested in what the Company considered to be Section 790 utility property. The Audit Report concluded that San Gabriel's recordkeeping for net proceeds from sales and condemnations was inadequate, because it did not protect against commingling of those proceeds with other Company funds and so did not ensure that all proceeds were invested in utility plant. Apparently the Audit Report would require an accounting system to ensure that the very same dollars received in proceeds are reinvested in the water system infrastructure - a concern which is both meaningless and unusual.
San Gabriel treated not only sales to private parties and to governmental agencies but also involuntary conversions by condemnation, service duplication, and contamination as sales of real property for accounting, tax, and ratemaking purposes. The proceeds were listed in San Gabriel's federal and state income tax returns.
The outstanding accounting issues are limited to deciding whether San Gabriel should be required to amend its general ledger and prior years' financial statements. We find that because neither of the requested accounting changes would have any ratemaking consequences but would impose costs and difficulties on the Company, we will not require them.
The need for tracking derives from the requirement of Section 790(a) that "[f]or purposes of tracking the net proceeds and their investment, the [utility] shall maintain records necessary to document the investment of the net proceeds . . . ." San Gabriel's method of tracking the proceeds of various transactions was to deposit the proceeds in the Company's general bank account and invest it in utility property. San Gabriel's documentation tracked the investment of the proceeds by job numbers, referring to utility plant investments made within one year, and exceeding in each case the amount of the proceeds.
The Audit Report contends that because San Gabriel did not establish a memorandum account in which to record proceeds of sales and condemnations, it was unable to determine whether the funding for plant infrastructure came from such proceeds or from operations. Further, out of concern that commingling the proceeds with other cash allows a utility to apply them for non-Section 790 purposes and then replenish the account with other funds, the Audit Report recommended that the Commission require that all such proceeds be deposited into a special bank account restricted to Section 790 investments.
The Audit Report exalts form over substance. Although a memorandum account would be easier to review than San Gabriel's method, we had not required San Gabriel to utilize one for Section 790 proceeds. The records San Gabriel did keep were adequate to show the receipt of funds and the expenditure of funds. Those records are in evidence which we have reviewed and find adequate. We had no trouble following the money trail. The Audit Report standard that the exact dollars received must be the ones expended on Section 790 plan is meaningless. Nor is it reasonable to have San Gabriel open separate bank accounts for Section 790 proceeds. We should not add workload and costs to no benefit. While Section 790 does not require a memorandum account, San Gabriel does not oppose establishing a memorandum account for Section 790 purposes on a going-forward basis. We will require one.
The Audit Report includes an analysis of San Gabriel's cash flows (including both Los Angeles and Fontana Divisions) over the years from 1990 to 2004, concluding that San Gabriel would have had a cash shortage after paying dividends but for the cash gains described above. The Audit Report contends that payment of over $40 million in dividends during the years from 1996 to 2004 calls into question the investment in Section 790 plant and asserts instead that those proceeds were used to pay dividends. This is one of the bases for the Audit Report's recommendation that $27.5 million plus interest be allocated to ratepayers.
San Gabriel strongly objected to the allegation that the gains were paid out as dividends. It maintains it always had reinvested the net proceeds in utility plant consistent with Section 790. It refers to legal counsel memoranda giving instructions to reinvest the net proceeds in utility property, and notes that the Company consistently used the net proceeds as its primary source of capital for new projects. San Gabriel's expert testified that the Company's dividends originate from net income, and demonstrated that San Gabriel has had adequate accumulated earnings for all of the dividends it paid during the period identified in the Audit Report.
San Gabriel's expert said that the Company had a consistent dividend policy to pay dividends equaling about 6% of average common stock equity. The only exception was in 1999, when a special dividend of $4,960,800 was paid from the Company's unrestricted accumulated net earnings, not from proceeds received during that year from the County of San Bernardino which had been directly invested in construction projects. He analyzed San Gabriel's cash flows over the years 1990 to 2004 and concluded that the Company had more than sufficient cash flow from its operations alone to pay shareholder dividends, aggregating $51,026,400, over the 15-year period.
We have independently analyzed San Gabriel's retained earnings, and, assuming no Section 790 issue, we would find that the Company's annual earnings, excluding capital gains and extraordinary items, have been sufficient to pay its annual cash dividends. But the Section 790 issue is the crux of the problem.
During the period 1996 through 2004 San Gabriel paid dividends of $40.9 million. During the same period San Gabriel received $27.8 million in gains from sales, contamination, etc. During that same period, after making its investments in plant which included the $27.8 million gain, San Gabriel had approximately $41.0 million available to pay dividends.2 It is obvious that San Gabriel could not have paid $40.9 million in dividends and also invested $27.8 million in plant unless it considered the $27.8 million gain as Section 790 proceeds belonging exclusively to the Company.
The audit report concludes the approximately $27.8 million gain was not entirely Section 790 funds to be invested in plant for the account of San Gabriel, and that the ratepayers in the Fontana Division were entitled to $13,343,000 million of that gain. Had San Gabriel sequestered the ratepayers' portion of the gain it would have fallen that amount short in its dividend payment. Rather than dividends of $40.9 million the maximum dividend would have been about $27.6 million. A slightly different analysis of the numbers shows that San Gabriel would have had a cash shortage of $43,088,611 after $51,026,400 in dividends during the years 1990 to 2004, if not for the fact that San Gabriel had received cash of $39,287,285, comprised of $35,179,336 in Other Net and $4,107,949 in Sale of Property Rights. Other Net plus sale of Property Rights include $27,811,312 in gains proceeds that San Gabriel received during 1996 to 2004 from contamination lawsuit settlements, service duplication, sale on condemnations, and sale to property owners. Of the $51,026,400 dividends paid during 1990 to 2004, $40,855,200 was paid during 1996 to 2004. San Gabriel would not have been able to pay $40,855,200 in dividends without the $27,811,311 cash inflow from gains proceeds which included $13,901,748 from the Fontana Division.
From this DRA contends that unless San Gabriel can explain how $40,855,200 in dividends can be paid to shareholders without using the $13,901,748 of Fontana Division proceeds, these proceeds were used for paying shareholder dividends. By using those proceeds to pay dividends, DRA believes San Gabriel had no intention to reinvest the $13,901,748 of Fontana Division proceeds in Section 790 plant infrastructure within the required eight-year period; Section 790 requires that the net proceeds and interest that is not invested after the eight-year period must be allocated solely to ratepayers. Therefore, DRA, the City, and the District recommend that San Gabriel allocate to Fontana Division ratepayers $13,901,478 in net proceeds, plus interest.
We agree with DRA that San Gabriel could only pay $40.9 million in dividends by using the gain proceeds as if they were San Gabriel's exclusively. But San Gabriel's dividend payment did not affect its ability to serve. No harm was done. Section 790 is satisfied if the gain on sale of real property is invested in infrastructure. It is sufficient that the amount of gain can be tracked into utility infrastructure, by company "records necessary to document the investment of the net proceeds...." (Section 790(a).) To the extent that Section 790 applies to this case, we have found that San Gabriel's records meet the test of Section 790. DRA's recommendation is denied.
The Audit Report, adjusted as shown in Ex. 64, identified the following proceeds and net proceeds (after retirements) from transactions relating to the Fontana Division:
Proceeds |
Net Proceeds | |
Proceeds of contamination claim |
$ 8,559,863 |
$ 8,559,863 |
Service duplication judgment |
$ 2,314,538 |
$ 2,314,538 |
Sales under threat of condemnation |
$ 2,520,148 |
$ 2,421,727 |
Sales to private parties |
$ 507,199 |
$ 431,004 |
Condemnation proceeds |
$ 22,500 |
$ 22,500 |
More proceeds of contamination claim |
$ 26,114 |
$ 26,114 |
TOTAL |
$ 13,950,362 |
$ 13,775,746 |
San Gabriel invested all the net proceeds in new plant necessary or useful for utility service. That new plant is included in the rate base on which San Gabriel has an opportunity to earn a return, except for the $2,618,291 investment in wellhead treatment facilities at Plant F-10, which the Commission already has deducted from rate base as CIAC (D.04-07-034). Thus, the present allocation of net proceeds from the various transactions is, in effect, $11,161,455 to shareholders and $2,618,291 to ratepayers.
San Gabriel states that in calculating net proceeds the Audit Report did not consider the legal and expert consultant costs incurred by San Gabriel in obtaining the proceeds and the income taxes that must be paid. San Gabriel says those factors are especially relevant with respect to the proceeds obtained in settlement of San Gabriel's claims against the County of San Bernardino in the Mid-Valley Landfill contamination case and against the City of Fontana in a service duplication case, and also with respect to the proceeds from sales under threat of condemnation. San Gabriel claims that $1,050,499 in legal costs attendant to these matters were never included in a memorandum account or recovered through rates. The only memorandum account authorized to accumulate such costs, the Water Quality Litigation Memorandum Account, was not established until 2002, after all costs relevant to the proceeds at issue had been incurred.
DRA opposes any reduction of net proceeds for legal costs. It points out that in prior rate cases, legal expenses were included in the determination of San Gabriel's rates. It refers to the Fontana Division rate case, D.04-07-034, which says "San Gabriel analyzed its outside legal costs over a 10-year period to develop an average, normalized estimate applicable to Fontana Division." (p. 22.) In that decision the Commission adopted San Gabriel's estimate based on a 10-year average. Those ten years included the years in which the legal costs San Gabriel is attempting to utilize as an offset were incurred. Thus, DRA concludes, those costs have already been factored into base rates and have already been recovered. Those legal costs were not deferred on the Company's books in prior years, were not included in a memorandum account for future recovery, and were effectively recovered from ratepayers in base rates. DRA believes that to allow San Gabriel to now offset the net proceeds with legal costs would in effect allow San Gabriel to double recover the legal expenditures. Ratepayers should not be asked to reimburse San Gabriel twice for its litigation expenses.
San Gabriel responds that legal fees and other litigation expenses incurred in achieving a favorable settlement with San Bernardino County were not borne by ratepayers, predated the Commission's authorization of a Water Quality Litigation Memorandum Account, and occurred between rate cases, so the Company bore the entire cost and risk associated with that litigation. Therefore, ratepayers should now pay those costs.
We do not agree with DRA's double recovery theory. With respect to the contamination proceeds, we believe it is appropriate to allow the cost of litigation to be deducted from the awarded damages. The actual gain that resulted from the contamination sales, must account for the litigation expenses incurred to realize that gain. To do otherwise negates the concept of "net" proceeds.
For gains resulting from condemnation, sales under threat of condemnation and inverse condemnation resulting from service duplication we will determine the proper treatment of legal costs at the time we determine the proper ratemaking treatment. It is appropriate to do so at that time because the allocation of the gains may impact the determination as to whether legal costs should be deducted from the proceeds.
The Audit Report failed to deduct income taxes associated with its recommendation to allocate the net proceeds to ratepayers. San Gabriel contends the Audit Report's proposal is flawed because the Company is obligated to pay those income taxes.
All parties agree that San Gabriel has taken advantage of the tax avoidance provision of the IRC to the full extent permissible for its gains from contaminations and involuntary conversions.3 Internal Revenue Service (IRS) code § 1033 provides:
§ 1033. Involuntary conversions
(a) General rule. - If property (as a result of its destruction in whole or in part, theft, seizure, or requisition or condemnation or threat or imminence thereof) is compulsorily or involuntarily converted -
(1) Conversion into similar property. - Into property similar or related in service or use to the property so converted, no gain shall be recognized.
(2) Conversion into money. - Into money or into property not similar or related in service or use to the converted property, the gain (if any) shall be recognized except to the extent hereinafter provided in this paragraph.
(A) Nonrecognition of gain. - If the taxpayer during the period specified in subparagraph (B), for the purpose of replacing the property so converted, purchases other property similar or related in service or use to the property so converted, or purchases stock in the acquisition of control of a corporation owning such other property, at the election of the taxpayer the gain shall be recognized only to the extent that the amount realized upon such conversion (regardless of whether such amount is received in one or more taxable years) exceeds the cost of such other property or such stock. Such election shall be made at such time and in such manner as the Secretary may by regulations prescribe. For purposes of this paragraph -
(i) no property or stock acquired before the disposition of the converted property shall be considered to have been acquired for the purpose of replacing such converted property unless held by the taxpayer on the date of such disposition; and
(ii) the taxpayer shall be considered to have purchased property or stock only if, but for the provisions of subsection(b) of this section, the unadjusted basis of such property or stock would be its cost within the meaning Section 1012.
The 9th Circuit has held that:
The purpose of this section relating to non-recognition of gain in the case of involuntary conversion of property due to condemnation is to relieve the taxpayer of unanticipated tax liability arising from the involuntary condemnation by freeing him from liability to the extent that he reestablishes his prior commitment of capital within the statutory period. Filippini v. U.S., C.A.9 (Cal. 1963), 318 F.2d 841, certiorari denied 84 S.Ct. 267, 375 U.S. 922, 11 L.Ed.2d 165.
This section is to be liberally construed to accomplish its purpose. (Davis v. U.S. CA.9 (Hawaii) 1979, 589 F.2d 446.)
It is uncontrovertible that the purpose of the statute being to "relieve the taxpayer of unanticipated tax liability" it follows that San Gabriel, having no tax liability, cannot charge the ratepayers for phantom taxes. The IRS has not challenged the tax liability; nor should we. We find there is no tax liability on the gains San Gabriel achieved from involuntary conversions and contaminations.
San Gabriel and DRA have presented their methods for calculating net proceeds. To calculate the net proceeds in each class of transaction, the book value, if any, must be deducted. Then legal costs must be deducted to provide the pre-tax net proceeds. Then the applicable income taxes should be deducted. (On the facts of this case we are not deducting taxes.) San Gabriel proposes in late-filed Exhibit 86a, that the appropriate tax factor, combining the effects of federal and state income taxes, is 40.746%. Thus, in San Gabriel's opinion, the net proceeds, net of income tax, are as follows:
Fontana Division |
Excess Proceeds |
Legal Costs |
Net Proceeds |
Net of Tax |
Contamination |
$ 8,559,863 |
$ 8,351,309 |
$ 4,948,485 | |
Service duplication |
$ 2,314,538 |
$616,835 |
$ 1,697,703 |
$ 1,059,569 |
Condemnation sales |
$ 2,421,727 |
$225,110 |
$ 2,196,617 |
$ 1,301,583 |
Private sales |
$ 431,004 |
$ 431,004 |
$ 255,387 | |
Condemnation order |
$ 22,500 |
$ 22,500 |
$ 13,332 | |
Contamination (more) |
$ 26,114 |
$ 26,114 |
$ 15,474 |
San Gabriel observes, if the Commission determines that some percentage of proceeds in one or more of the above categories should be allocated to ratepayers, that percentage should be applied only to the "Net of Tax" amounts.
Looking at the several classes of proceeds, based on the evidence developed in this proceeding we reach the following conclusions:
Sales to private parties: $431,004. San Gabriel fully documented the status of the properties involved as being no longer necessary or useful. These sales were made subject to Section 790 and San Gabriel satisfactorily tracked the receipt of proceeds and their reinvestment in water system infrastructure necessary or useful for utility service. These reinvestments should continue to be recognized as shareholder investments included in rate base.
Sales under threat of condemnation: $2,421,727. We defer determination of the regulatory treatment of proceeds from these sales under threat of condemnation until after our policy determination on the issue of gain on sales under threat of condemnation in Phase II of R.04-09-003. There is no income tax.
Condemnation proceeds: $22,500. This was an involuntary conversion by court-ordered exercise of the power of eminent domain. We defer determination of the regulatory treatment of proceeds from condemnation until after our policy determination on the issue of condemnation in Phase II of R.04-09-003. There is no income tax.
Proceeds of service duplication judgment: $2,314,538. This was an involuntary taking by service duplication resulting in payment by the City of Fontana to San Gabriel pursuant to a court judgment. We defer determination of the regulatory treatment of proceeds from service duplication judgment to Phase II of R.04-09-003. There is no income tax.
Proceeds of contamination claim: $8,559,863 plus $26,114, less litigation costs of $208,554. This was a claim for damages as a result of the destruction in whole or in part of the Company's property and water rights by groundwater contamination from the Mid-Valley Landfill resulting in payment by the County of San Bernardino to San Gabriel pursuant to a settlement. This is not a sale within the meaning of Section 790. For federal tax purposes the Company has considered this the destruction of its property. There is no income tax. The net proceeds of $8,377,923 will be divided 50/50 between shareholders and ratepayers.4
The total allocation of gain to ratepayers is $4,188,712, which should be recorded as CIAC. In D.04-07-034 we had allocated $2,618,291 of that gain to CIAC. The result of this decision is to add $1,570,421 more to CIAC which reduces rate base by an equivalent amount.
The ratemaking effects of the dollars allocated to ratepayers is to add those dollars to CIAC, thereby reducing rate base by that amount. This shall be done for rate base for TY 2006-2007 and going forward. In regard to the rate base utilized to compute the revenue requirement in D.04-07-034, the dollars allocated to ratepayers will be added to CIAC in D.04-07-034, thereby reducing rate base by that amount. The revenue requirement in D.04-07-034 will be recomputed and the difference in rates for the period July 17, 2004 through the effective date of this decision will be refunded to current ratepayers on a cents per ccf of use.
The rate base for this decision is $86,123,679. (Appendix A, p. 1.) The rate base for D.04-07-034 will be recomputed to reduce it by $1,570,421 (Appendix E, p. 2). The revenue requirement for D.04-07-034 will be recomputed to reduce it by $271,300. (Appendix E, p. 2.) The amount to be refunded as of July 1, 2006 is $573,278, and as of December 31, 2006 is $719,100 (Appendix E, p. 1).
Section 790's applicability to San Gabriel's investments in plant has been decided in this case. However, the details that relate to the Los Angeles County Division ratemaking are not within the scope of this proceeding and only Fontana Division revenues and rates are affected. Accordingly, the parties have addressed only the status and ratemaking treatment of proceeds from surplus property sales and involuntary conversions affecting the Fontana Division. The proper forum for any ratemaking effects in connection with these transactions for San Gabriel's Los Angeles County Division will be the next GRC for the Los Angeles County Division.
XIV. Customer Service
During DRA's review at the Company's offices, San Gabriel provided a copy of the customer complaint logs for water quality regarding taste, odor, turbidity, and pressure. Based on a review of the completed forms, DRA says that San Gabriel has adequately resolved the water quality issues arising during the period reviewed. We agree.
DRA reviewed the customer bill inquiry forms. The Company had summaries regarding billing inquiries, but not the actual billing inquiry forms other than for the month of September 2005. In the past, the number of bill inquiries identified in the Company's files consists only of the bill inquiries that are tracked in the Company's billing inquiry log. Only the billing inquiries where an employee went out to a customer's premises and actually met with a customer in person were reported in the log.
DRA recommends that San Gabriel immediately begin keeping a copy of each bill inquiry form in a separate, centrally located file. This will allow for complete and accurate bill inquiry reporting, and would allow DRA to review future bill inquiries. San Gabriel agrees with DRA's recommendation and set-up a separate centrally located file for bill inquiries beginning January 1, 2006.
XV. Penalties
Pursuant to the Commission's Rules of Practice and Procedure, Rules 1 and 1.5, and Pub. Util. Code § 2107, DRA, the City, and the District request monetary penalties be assessed against San Gabriel.
In D.98-12-075, Standards of Conduct Governing Relationships Between Energy Utilities and Their Affiliates, we compiled "the principles that the Commission has historically relied upon in assessing fines and restates them in a manner that will form the analytical foundation for future decisions in which fines are assessed." (84 CPUC 2d 155, 193.) The decision is concerned with energy utilities and their affiliates, but it explains the principles the Commission utilizes in determining fines against all utilities. Pub. Util. Code § 702 is particularly pertinent.
Every public utility shall obey and comply with every order, decision, direction, or rule made or prescribed by the Commission in the matters specified in this part, or any other matter in any way relating to or affecting its business as a public utility, and shall do everything necessary or proper to secure compliance therewith by all of its officers, agents, and employees.
Such compliance is absolutely necessary to the proper functioning of the regulatory process. Disregarding a statutory or Commission directive, regardless of the effects on the public, merits a high level of scrutiny. It violates the integrity of the regulatory process." (84 CPUC 2d at 193.)
DRA sums up its penalty request:
DRA proposes setting a fine that will deter future violations not only of San Gabriel, but of other companies in the water industry. San Gabriel cannot be rewarded for actions that thwarted and attempted to subvert the regulatory process. ALJ Barnett's proposed split of the proceeds of 75% to ratepayers and 25% to shareholders would encourage such bad behavior because San Gabriel would be allowed to retain one-quarter of its ill-gotten gains. Therefore, 100% of the audit proceeds should be assigned to ratepayers as CIAC. DRA proposes a fine within the range of $100,000-$500,000. An amount in this range would provide effective deterrence to the industry and to San Gabriel. (DRA O.B. p. 104.)
DRA accuses San Gabriel of "misapplication of Section 790 to its condemnation, service duplication, and contamination settlement proceeds." (DRA O.B., at 101.) This refers to the Audit Report's assertion that of the entire $13.9 million of gain in the Fontana Division, only $431,000 relating to surplus property sales to private parties clearly was subject to Section 790. San Gabriel responds that, absent contrary guidance from the Commission it believes all of the proceeds at issue are subject to Section 790. Further, to the extent that any proceeds are not subject to Section 790, then DRA's allegations about inadequate tracking of those proceeds are irrelevant.
DRA asserts that San Gabriel diverted $13.9 million to its shareholders "that should have been reinvested in Section 790 plant infrastructure," using that entire amount to fund dividends. San Gabriel responds that dividends were paid from unrestricted net earnings. We have discussed this above under Payment of Dividends and repetition is not needed. Suffice it to say San Gabriel invested adequate amounts in plant during the period in question. San Gabriel's dividend policy did not harm or impact ratepayers and does not merit a penalty.
DRA accuses San Gabriel of "improper accounting" for the proceeds at issue, and complains about San Gabriel's having disregarded Section 790. DRA alleges that San Gabriel acted in "defiance of Section 790" by its commingling of the proceeds at issue and in "defiance" of Cal Water, D.03-09-021, by not tracking Section 790 proceeds with a memorandum account.
We have discussed those issues above and will not repeat, except to reiterate that San Gabriel never has been ordered not to commingle Section 790 proceeds with other funds nor was it a party to the Cal Water case; San Gabriel's records were sufficient for us to track the proceeds.
DRA's concerns regarding Section 790 and the concerns of the City and the District baffle us. Apparently, DRA's position is that these are Section 790 funds which require a memorandum account, which San Gabriel failed to establish. If it were true that these are Section 790 funds the ratepayers would not be receiving a refund, would not benefit from a lower rate base, would not have lower rates, and would have every right to complain of continuing high rates. The mere failure to establish a memorandum account would not merit in a $13.9 million disallowance.
The one transaction that does merit a penalty is the affiliate transaction sale by Rosemead Properties to San Gabriel of a parcel of land to be used for a new headquarters complex. As we said earlier, this is an egregious violation of our affiliate transaction rules. In this instance we agree with DRA's assertion that San Gabriel has failed to meet its responsibility to become familiar with and to comply with applicable laws, regulations, and Commission orders.
The Commission discussed the overall guidelines for determining fines in D.98-12-075, In re Standards of Conduct Governing Relationships Between Energy Utilities and Their Affiliates, 84 CPUC 2d 155, and reiterated them and applied them to water companies in D.99-11-044, Strawberry Property Owners Ass'n v. Conlin-Strawberry Water Co., and D.05-11-030, Casmalia Community Services v. Unocal Corp. The purpose of a fine is to deter future violations by the perpetrator or others. The severity of the offense and the perpetrator's conduct guide the Commission in setting a fine that is proportionate to the offense.
In D.97-12-088 (77 CPUC 2d 422, 479) we codified the rule that in an affiliate transaction purchase the utility shall record on its books the lower of fair market value or cost. This was merely a restatement of a long-standing policy of the Commission. When a utility acquires from an affiliate property used or useful in its utility business, the valuation of that property for ratemaking purposes should be the amount which would be the net book value of the property had the utility, rather than its affiliate acquired the property directly. (D.75573, 69 CPUC 445, 467 (1969).)
We have already discussed the affiliate transaction violation regarding the purchase of land for the new headquarters building, and will not repeat it.
The Commission is authorized by § 2107 to levy a fine of $500 to $20,000 for violation of our rules, orders, statutes, etc.
§ 2107: Any public utility which violates or fails to comply with any provision of the Constitution of this state or of this part, or which fails or neglects to comply with any part or provision of any order, decision, decree, rule, direction, demand, or requirement of the Commission , in a case in which a penalty has not otherwise been provided, is subject to a penalty of not less than five hundred dollars ($500), nor more than twenty thousand dollars ($20,000) for each offense.
We conclude that San Gabriel's should be fined $20,000 for the affiliate transaction violation pursuant to our authority under § 2107.
In determining the fine we are mindful of the standards adopted in D.98-12-075 (84 CPUC 2d 1575, 188-190).
Harm to the Regulatory Process: A high level of severity will be accorded to violations of statutory or Commission directives, including violations of reporting or compliance requirements.
San Gabriel has violated an affiliate transaction policy that goes back to one of the basic purpose of utility regulation, abuses involving holding companies. (See, Phillips, the Regulation of Public Utilities (1988) 578-583.)
The Utility's Actions to Detect a Violation: Utilities are expected to diligently monitor their activities. Deliberate, as opposed to inadvertent wrongdoing, will be considered an aggravating factor. The level and extent of management's involvement in, or tolerance of, the offense will be considered in determining the amount of any penalty.
Management's involvement in this breach of trust was 100%; at the very top level of the utility and the holding company. San Gabriel is no stranger to failing to provide complete information to the Commission. In D.48942 we dismissed its rate application because it failed to disclose material information. (Re San Gabriel Valley Water Co., 52 CPUC 729.) We affirmed D.48942 in D.49074 (52 CPUC 741; writ of review denied, S.F. 18940.) The language of the Commission in D.49074 is particularly blistering.
The affiliated interests with which the law and factual substance are concerned are the domination and control which the president of applicant exercises over both applicant and [its affiliate]. It is a case of the president of applicant dealing on behalf of applicant with himself as the alter ego of [its affiliate]. The law does not permit an official of a corporation to profit by dealings he has with such corporation. It follows that the Commission is duty bound to prevent the ratepayers of applicant from being saddled with the burden resulting from profits made by applicant's president at the expense of applicant. That such unreasonable charges may be disallowed by the Commission for the purposes of rate-fixing is beyond question. (Pacific Telephone and Telegraph Co. v. Public Utilities Commission, 34 Cal (2d) 822, 826)." (52 CPUC 741,742.)
Need for Deterrence: Fines should be set at a level that deters future violations. Effective deterrence requires that the size of a fine reflect the financial resources of the utility.
The Commission's Rules of Practice and Procedure (Rule 1) states:
Any person who signs a pleading or brief, enters an appearance at a hearing, or transacts business with the Commission, by such act represents that he or she is authorized to do so and agrees to comply with the laws of this State; to maintain the respect due to the Commission, members of the Commission or its Administrative law Judges; and never to mislead the Commission or its staff by an artifice or false statement of fact or law.
Our authority to impose penalties for San Gabriel's violation of Rule 1 is provided for in § 701, which states that the Commission is "empowered to supervise and regulate every public utility in the state and may do all things...which are necessary and convenient in the exercise of such power and jurisdiction."
San Gabriel knowingly provided misleading information to the Commission regarding issues that are material to this proceeding. The submittal of false information causes substantial harm to the regulatory process, which cannot function effectively unless participants act with integrity at all times.
In this instance we are limited by § 2107 to imposing a $20,000 fine for each violation. We find three violations: (1) the affiliate transaction itself (2) the failure to report the violation when it occurred and, (3)a Rule 1 violation in failing to disclose and actually concealing the transaction in its exhibits in this rate case (i.e., Exhibit 1, Table 8A, p. 8-4, land and land rights, 2004). The problem here is that the Commission is limited in its deterrence to a $60,000 fine, when, if the transaction had gone undiscovered, the holding company would have benefited by $500,000.
Within 30 days from the effective date of this order, San Gabriel shall remit to the Commission's Fiscal Office at 505 Van Ness Avenue, Room 3000, San Francisco, CA 94102, a check for $60,000made payable to the State of California's General Fund. The number of this decision shall be shown on the face of the check.
XVI. Assignment of Proceeding
John A. Bohn is the assigned Commissioner and Robert Barnett is the assigned ALJ in this proceeding.
XVII. Comments on Proposed Decision
The proposed decision of the ALJ in this matter was mailed to the parties in accordance with Pub. Util. Code § 311(d) and Rule 77.1 of the Commission's Rules of Practice and Procedure. An alternate decision by the assigned Commissioner was filed concurrently with the proposed decision. Comments on both were filed ______________. Reply comments on both were filed _______________.
1. San Gabriel's forecast that its number of active service connections will increase at a rate of 1,350 new connections per year and its estimates of annual use by every customer class except for large industrial customers is adopted.
2. San Gabriel forecasts sales on a weather-normalized basis for most customer classes by applying the New Committee Method to recorded monthly sales over the last ten years. This forecast method is adopted.
3. DRA's estimate of test year sales to Cemex of 250,685 ccf is more reflective of Cemex's current and anticipated water use, and is adopted.
4. DRA's recommendation that sales to CSI be projected at 545,700 ccf, a level 283,140 ccf higher than San Gabriel's test year estimate, is adopted.
5. San Gabriel's approach to the allocation of the $116,909 received from US EPA is to amortize it over three years, increasing the water revenue account by $38,970 in the test year. San Gabriel's proposal is reasonable and is adopted.
6. A 6.2% unaccounted for water factor is adopted.
7. DRA has reached an agreement with San Gabriel that San Gabriel's proposed $8,509,500 water costs (177.88/AF) forecast for TY 2006-2007, is reasonable. However, as DRA has recommended an adjustment to increase the company's projected sales to CSI by 650 AF, DRA has also increased the projected purchase water costs by $115,622 (650 AF x $177.88/AF) to $8,625,122. DRA's recommendation is adopted.
8. Purchased power costs of $4,795,500, or $0.094782/kWh, forecast for TY 2006-2007 are reasonable and adopted. Purchased power costs go through a full cost balancing account.
9. An annual chemical expense of $637,410 for TY 2006-2007, is reasonable and adopted.
10. Using updated September 30, 2005 escalation factors, DRA's recommendations for materials and supplies expenses are: $142,300 for operations, $282,900 for maintenance and $40,300 for administrative and general expenses. These are adopted.
11. A TY 2006-2007 transportation expense of $619,323 is reasonable and adopted.
12. In projecting TY 2006-2007 postage expense, the company applied non-labor escalation rates as well as the 5.4% postage rate increase. It is adopted.
13. The maintenance expense element of outside services varies directly with the quantities of physical plant. San Gabriel increased to $187,100 the recorded year 2004 amount to reflect both increases in plant and non-labor escalation rates. San Gabriel's estimate is adopted.
14. San Gabriel estimated $287,795 in TY 2006-2007 for non-perchlorate related legal costs, based on a ten-year average expense level, inflated to 2004 dollars, then escalated to TY 2006-2007. To provide for the possibility of high fees we will adopt San Gabriel's estimate, but to also provide for the possibility of an average expense we require San Gabriel to create a memorandum account to record outside legal expenses, capped at $287,795 per year. Money not reasonably expended shall be returned to the ratepayers.
15. Perchlorate related legal expenses are accounted for through the Water Quality Litigation Balancing Account and are not factored into base rates. This is reasonable and adopted.
16. San Gabriel has agreed to use the ECSB labor inflation rates, thereby reducing its proposed revenue requirement for TY 2006-2007 by about $330,000, while also agreeing to apply the September 2005 version of the ECSB escalation factors. We adopt the methodology and apply it throughout to our adopted expenses.
17. The 12 positions that were vacant as of November 14, 2005 shall be removed in determining TY 2006-2007 payroll expense as its normal to have some level of vacancies in any given period.
18. Of the 12 proposed new positions, we approve 11. We do not approve including in expenses one Water Treatment Operator III.
19. Step increase for employees shall be removed from expenses.
20. It is reasonable to substitute ECSB's September 2005 Labor Inflation Rates for San Gabriel's use of ECSB's June 2005 Compensation per Hour Index. This is adopted.
21. Vacation, holiday, and sick leave expenses are adjusted to reflect our adopted revision to payroll.
22. For 401(k) costs, we change the escalation factor from the Compensation per Hour Index to the Labor Inflation Rate and recalculate the expense based on our adopted revisions to payroll.
23. We modify the health and dental insurance expense to reflect the impact of our revisions to payroll.
24. San Gabriel's Business Property and Umbrella Liability Insurance expenses are adopted.
25. We modify San Gabriel's worker's compensation expense by adjusting for the payroll increase that we have adopted and by offsetting the expense by the three-year average of refunds received, $24,000 of which Fontana Division's portion is 38%. We will not adjust the Ex Mod factor.
26. San Gabriel's Regulatory Commission expense and amortization is adopted.
27. DRA's proposed uncollectible factor of 0.1951% is adopted, modified to reflect our projected revenue.
28. San Gabriel's incorporated franchise fee expenses based on a five-year recorded average franchise fee rate of 0.8091% is adopted.
29. The general office allocation costs are allocated between the Los Angeles Division and the Fontana Division based on a four-factor allocation formula. It is adopted.
30. The American Jobs Creation Act of 2004 provides for a deduction equal to 3% qualified production activities income in 2005 and 2006 and 6% of qualified production activities income in 2007 and 2008. As the applicable deduction is 3% for 2006 and 6% for 2007, we shall utilize an average deduction rate for TY 2006-2007 of 4.5%. San Gabriel has estimated the percentage of its net income applicable to production activities to be 51.9%, which we find reasonable and adopt.
31. San Gabriel shall compute its income tax expense to reflect the impacts of the 2004 Act.
32. Taxes Other Than Income include property and payroll taxes. San Gabriel and DRA agree on the amount for Other Taxes except for payroll. We adopt their recommendation but will use our independent findings on payroll.
33. The Fontana Division is confronted with increased demand throughout its service area as the result of rapid new development. Recognizing the need for an update plan to address the growing demands on its water supply and distribution system, in October of 2003, San Gabriel prepared a comprehensive Water Master Plan.
34. The Master Plan addressed the rapid growth in the undeveloped northerly portions of Fontana Division's service area and additional industrial growth in the southerly areas, both of which will require new wells along with new reservoirs (for fire flow requirement and peak demand), booster pumps, and transmission and distribution pipelines to provide necessary flows at appropriate pressures.
35. The Master Plan estimates that approximately 25 mgd of additional groundwater supply is needed by the year 2010 in order to meet increased demands and to increase the reliability of the system. This estimate is reasonable.
36. The Master Plan recommends that the Company have redundant well capacity for at least three 2,000 gpm wells. The Master Plan recommends a total of eight new groundwater production wells (including three wells to provide redundant well capacity), each with a capacity of approximately 2,000 gpm, for a total capacity of approximately 16,000 gpm, be installed prior to 2010. This recommendation is reasonable.
37. The Master Plan concluded that the Fontana Division has a current deficiency of 19 mgd under drought conditions, requiring construction of new and replacement wells that will produce at least 25 mgd as well as construction of a seven mgd perchlorate treatment facility that will treat three contaminated wells, in order to overcome the current deficiency, meet year 2010 maximum day demands under drought conditions, and provide sufficient redundancy during emergency interruptions. We find this conclusion to be reasonable.
38. The Sandhill Surface Water Treatment Plant began operation in 1965. The plant relies on surface water diversions from Lytle Creek but often must be shut down and when Lytle Creek has high levels of turbidity that exceed the current treatment capability of the Sandhill plant. The other source of supply for the Sandhill plant is State Water Project (SWP) water that must be blended with Lytle Creek surface water before it can be treated. These blending requirements restrict the capacity of the Sandhill plant to the availability of useable Lytle Creek surface flow. The required shutdown of surface water processing through the Sandhill plant has deprived the Fontana Division of thousands of acre feet of low-cost surface water, including over 25,000 acre feet just in the first five months of 2005.
39. The planned upgrades and pretreatment facilities will permit the Sandhill plant to treat 100% Lytle Creek surface water, 100% SWP water, or any blend of the two. This will restore the full usefulness of the Sandhill plant even when Lytle Creek surface water is unavailable or too muddy, because the plant will be able to process SWP water.
40. The Commission adopted a Water Action Plan on December 15, 2005, which contained various objectives expected to be implemented by the investor-owned water utilities.
41. The Sandhill plant upgrade project is expected to cost approximately $35 million, to which must be added staffing and maintenance. San Gabriel's TY 2006-2007 rate base includes $12 million already expended on the Sandhill plant.
42. For new construction the most equitable way to provide recovery in rates is to continue the solution found reasonable in D.04-07-034 to limit rate base growth to 10% per year, excluding the ratebase additions caused by the Sandhill plant upgrade. We are not disposed to dictate to San Gabriel which plant will be constructed in which order; that is a management decision.
43. New wells are needed to meet the demands of new customers; new customers should be contributing to provide the plant necessary to serve them.
44. The cost of the treatment facility at Plant F-25 should be treated as CIAC, if the company recovers funds from its contamination lawsuits.
45. San Gabriel has neglected to emphasize developer funds to provide new facilities for new customers. The need for plant arises not only to serve current ratepayers, but also to serve new customers. New customers should contribute new facilities. We need not decide at this time which facilities will serve new customers.
46. San Gabriel should install a replacement 10,000 gpm CVWD interconnection to maximize deliveries during emergencies.
47. To construct a new office/warehouse, San Gabriel acquired 4.81 acres for the new facility, on December 30, 2004 for $1,102,233 from Rosemead Properties Inc. (Rosemead), an affiliate company of San Gabriel. The acquired parcel was part of an 8.72 acres parcel originally acquired by Rosemead on July 8, 2003 for $1,075,000.
48. Rosemead is owned by United Resources, Inc. (United Resources.) United Resources also owns San Gabriel. Rosemead purchased the property during the time that San Gabriel was seeking land on which to construct a new office building. The land was expected to go into rate base. When the land was sold by Rosemead to San Gabriel in December 2004 it occurred without any negotiation regarding price.
49. We will allow $591,250 in rate base calculated on the ratio of the size of the parcel Rosemead sold to San Gabriel to the size of the larger parcel of which it was part. We find that San Gabriel should have been charged 55% of $1,075,000, or $591, 250 for the land. This violation of the affiliate transaction is particularly egregious.
50. In regard to the new office/warehouse, San Gabriel should remove the facilities that are to be replaced from ratebase immediately upon the occupation of a new headquarters building. If sold, the facilities should be given Section 790 treatment.
51. We would expect a higher CWIP for TY 2006-2007 because of the major projects under construction. We find that the Company's CWIP estimate is probably low, but reasonable. We specifically allow up to $4.9 million to be included in CWIP for the new headquarters building.
52. We find reasonable San Gabriel's forecast method for materials and supplies, reflecting plant growth as well as general inflation (using updated inflation factors).
53. The additions to the advance for construction account for the past five years averaged $3 million. The additions projected for 2005-2008 average $2 million. The growth that creates the need for additional plant should be either advanced or contributed by developers. The advance estimate is low but reasonable.
54. The additions to the CIAC for the past five years averaged $1.3 million. The Company's additions projected for 2005-2008 average $850,000. Historically, the $1.3 million represented approximately 11% of the $11.677 million average of gross plant additions. The difference between the actual and the estimates suggests that San Gabriel understated the projected contributions. We adopt the historical average for contributions of $1.3 million.
55. We adopt San Gabriel's working cash estimating method. It was done in accordance with Standard Practice U-16.
56. We adopt San Gabriel's methodology in determining the depreciation expense based upon our adopted estimates of utility plant.
57. San Gabriel and DRA stipulated to the capital structure, cost of debt, ROE and overall rate of return for purposes of this GRC, agreeing on an ROE of 9.90%, and overall rate of return of 9.33% for TY 2006-2007 and 9.35% for TY 2007-2008. The stipulation is reasonable and is adopted.
58. DRA and San Gabriel proposed an imputed capital structure, consisting of 40% long-term debt and 60% common equity, an equity ratio approximately half way between the average equity ratio of a group of small water utilities and San Gabriel's actual equity ratio. This capital structure of 40% long-term debt and 60% common equity is reasonable and is adopted.
59. The stipulation between the DRA and San Gabriel results in a cost of long-term debt for each year, 2006-2008, based on the amounts proposed by San Gabriel. The agreed upon long-term debt rates are: 8.44% for 2006, 8.49% for 2007, and 8.54% for 2008. These debt rates are reasonable and are adopted.
60. Consistent with a 9.9% ROE, the overall rate of return for TY 2006-2007 at 9.33% and for TY 2007-2008 at 9.35% is reasonable and adopted.
61. San Gabriel seeks to phase into rates by advice letter filings the capital costs for its planned new headquarter complex ($3 million in the 2005 capital budget and $3 million in the 2006 capital budget) and for the post-2005 portion of the Sandhill Plant upgrade project ($18 million in 2006 and $4 million in 2007). An advice letter filing for a major addition to plant is not routine. It will have to be reviewed by the Water Division, DRA, possible protestants, and the Commission. Our three-year rate case plan can be seriously adversely impacted. A charge to CWIP will adequately protect San Gabriel. San Gabriel's advice letter proposal is approved for the Sandhill Plant upgrade, but denied for its planned new headquarters project.
62. San Gabriel's proposal to amortize the balance recorded in the Water Quality Litigation Memorandum Account as of June 30, 2006 is reasonable and is adopted. We will authorize a 24-month amortization of the June 30, 2006 balance in the account.
63. San Gabriel shall continue to maintain a Water Quality Memorandum Account.
64. San Gabriel's proposed net-to-gross multiplier is 1.800324. DRA proposed 1.77286, the difference being DRA's use of an uncollectibles rate of 0.1951% and a deduction for qualified production activities under the Jobs Act. We find reasonable a net-to-gross multiplier of 1.772805 based on the resolution of those issues.
65. In accordance with the RCP, TY 2007-2008 is a test year for items related to rate base and an escalation year for all other revenue requirement components, and TY 2008-2009 is an attrition year for rate base items and an escalation year for other components. We have followed the RCP requirements for test year, escalation, and attrition factors to produce the reasonable and adopted revenue requirement and rate increase calculations for escalation years 2007-2008 and 2008-2009.
66. A facilities fee minimum of $5,000 for a 5/8" x 3/4" meter is reasonable and will be authorized. Other water purveyors in the region charge between $5,000 and $7,000 per new home connected to the system and use those funds to pay for additional capacity needed to serve new customers. San Gabriel has presented persuasive evidence that their customer base is growing by about 2 ½% per year with concomitant growth in water usage. It proposes upgrades to its Sandhill plant, new wells, new reservoirs, and equipment to meet this growth. It is not unreasonable to require new customers to assist in paying for these new facilities through a facilities fee paid prior to connection. Higher meter sizes will pay according to the schedule in Table 2, above.
67. Given the uncertainty and volatility of real estate development, the revenue that a facilities fee would generate is highly uncertain both in amount and timing. Facilities fee revenues should be taken into account for ratemaking purposes once they have been received, through an advice letter.
68. The following procedures for facilities are adopted:
1. All fees collected must be kept in a separate interest bearing bank account and credited to CIAC at the time the fees are spent for additional plant.
2. The utility shall show the balances in its annual report to the Commission. Fund balances should be listed as debits to Account 132, and as credits to Account 253, other credits.
3. Interest should also be debited to Account 132, and credited to Account 421, non-utility income.
4. When plant is replaced using funds from these fees, a debit should be made to the appropriate plant account and a credit made to Account 271, CIAC.
5. The fee is applicable to all customers applying for service from the utility in the territory served for premises not previously connected to its distribution mains, for additional service connections to existing premises, and for increases in size of service connections to existing premises due to change in use.
69. To modify the monthly service charge to equalize it for new residences would be a change which would benefit occupants of recently constructed homes at the expense of customers with older residences. Such a rate change would run counter to a facilities fee. San Gabriel's monthly service charge is in compliance with the Commission's Water Rate Design Policy set forth in D.86-05-064. It is reasonable and is adopted.
70. San Gabriel's CARW program is reasonable and is adopted.
71. San Gabriel's Fontana Division received $13,775,746 in proceeds from various transactions during the years 1996 to 2004 from:
Fontana Division | |
Water contamination |
$ 8,559,863 |
Service duplication |
$ 2,314,538 |
Sale on condemnation |
$ 2,421,727 |
Sale to private property owners |
$ 431,004 |
Condemnation order |
$ 22,500 |
Contamination (more) |
$ 26,114 |
Total |
$ 13,775,746 |
72. The 24 sales to private parties in the Fontana Division during years 1996 to 2004 mainly involved release of easements or rights of way with lines damaged, threatened, or rendered unusable or hazardous by grading and construction operations. Those properties are no longer necessary or useful and the $431,004 gain San Gabriel received from property sales to private owners is governed by Section 790.
73. The ten Fontana Division sales on condemnations addressed in the Audit Report were sales under threat of condemnation. San Gabriel, as the selling party, admits that it was motivated to avoid the cost and confrontation of a pointless condemnation trial; in the light of that threat San Gabriel did enter into sales transactions.
74. On November 10, 1998, San Gabriel entered into a settlement with the County of San Bernardino where the County agreed to pay San Gabriel compensation for damaging San Gabriel's property by contamination from the County's Mid-Valley Sanitary Landfill. San Gabriel's received, for the period 1998 to 2004, $8,559,863 from the County.
75. San Gabriel's contamination lawsuit was a claim for damages; the settlement damage payment was not a sale of real property nor did it result in a sale. Section 790 requires a sale by the utility: no sale, no Section 790 relief. We will deduct the litigation costs of $208,554 from the proceeds of the contamination award of $8,559,863 for net proceeds of $8,351,309. We will allocate the net gains of $8,351,309, 50% to ratepayers and 50% to shareholders. This will assure and encourage the utility to vigorously pursue polluters.
76. The $26,114 contamination award dollars are not Section 790 proceeds, and will be allocated 50/50.
77. The gain allocated to ratepayers of $4,188,712 should be reduced by the cost of Plant F-10, $2,618,291, which is already in CIAC.
78. The $1,570,421 balance of gain allocated to ratepayers will be accounted for by reducing rate base by increasing CIAC by that allocation.
79. San Gabriel has maintained detailed records necessary to document its investment in utility plant of the net proceeds of property sales, contamination recovery, and involuntary conversion.
80. San Gabriel should not be required to amend its general ledger and prior years' financial statements because neither accounting changes would have any ratemaking consequences but would impose costs on the Company.
81. The records San Gabriel kept were adequate to show the receipt of funds and the expenditure of funds. However, we will require a memorandum account to record all transactions that result in gains from sale of real property, or gains from condemnations, service duplication, or contamination claims.
82. Water quality issues have been adequately resolved.
83. San Gabriel should set-up a separate centrally located file for bill inquiries beginning January 1, 2006.
84. The rate base for this decision is $86,791,500 (Appendix A, p. 1.) The rate base for D.04-07-034 will be recomputed to reduce it by $1,570,421 (Appendix E, p. 2). The revenue requirement for D.04-07-034 will be recomputed to reduce it by $276,037. (Appendix E, p. 2.) The amount to be refunded as of July 1, 2006 is $573,278 (Appendix E, p. 1).
85. The affiliate transaction sale by Rosemead to San Gabriel of a parcel of land to be used for a new headquarters complex merits a penalty. This is an egregious violation of our affiliate transaction rules. San Gabriel is responsible to become familiar with and to comply with applicable laws, regulations, and Commission orders. It has failed to meet that responsibility. Management involvement in this breach of trust was 100%; at the very top level of the utility and the holding company.
86. San Gabriel knowingly provided misleading information to the Commission regarding issues that are material to this proceeding. The submittal of false information causes substantial harm to the regulatory process, which cannot function effectively unless participants act with integrity at all times.
87. We find three violations: (1) the affiliate transaction itself; (2) the failure to report the violation when it occurred and; (3) a Rule 1 violation in failing to disclose and actually concealing the transaction in its exhibits in this rate case (i.e., Exhibit 1, Table 8A, p. 8-4, land and land rights, 2004). In this instance we are limited by § 2107 to imposing a $20,000 fine for each violation for a total of $60,000.
1. The ALJ Division shall offer a mediation service to assist the parties in achieving a solution to providing San Gabriel with the City's recycled water.
2. San Gabriel shall set up a memorandum account record outside legal expenses to be capped at $287,795 per year, the form of the account to be approved by the Water Division.
3. Determination as to the disposition of proceeds that result from condemnation, sale under threat of condemnation, and inverse condemnation are deferred to the policy determination in R.04-09-003.
4. The settlement of a groundwater contamination claim is not a sale of real property, and is not within the purview of Section 790.
5. The rates and charges set forth in Appendix D to this decision are just and reasonable for the test year and escalation years set forth.
1. San Gabriel Valley Water Company (San Gabriel) shall file within 30 days after the effective date of this order, in accordance with General Order 96-B, and make effective on not less than five days' notice, the revised tariff schedules for its Fontana Division included as Appendix D to this order. The revised tariff schedules shall apply to service rendered on and after their effective date.
2. Not later than May 15, 2007 and May 15, 2008, for escalation years 2007/2008 and 2008/2009 respectively, San Gabriel shall file advice letters in conformance with General Order 96-B proposing new revenue requirements (and corresponding revised tariff schedules) for the Fontana Division. San Gabriel advice letters shall follow the escalation procedures set forth in the Commission's Rate Case Plan for Class A Water Utilities, and shall include appropriate supporting workpapers. San Gabriel shall reduce the escalation year revenue requirement for Fontana to the extent its rate of return on rate base for the 12 months ending March 31, 2007 and March 31, 2008, taking into account the rates then in effect and normal ratemaking adjustments, exceeds the rate of return found reasonable in this order. The revised tariff schedules shall take effect on July 1, 2007 and July 1, 2008, respectively, and shall apply to service rendered on or after their effective dates. The proposed revised revenue requirements and rates shall be reviewed by the Commission's Water division. Water Division shall inform the Commission if it finds that the revised rates do not conform to the Rate Case Plan, this order, or other Commission decisions, in which case all revenues collected under the revised rates shall be subject to refund until the Commission has decided the matter.
3. San Gabriel shall refund to its ratepayers for the period July 17, 2004 to July 1, 2006, $573,278, plus the amount accrued from July 1, 2006 to the date its revised tariff schedules set forth in Ordering Paragraph 1 are effective. The refund shall be based on cents per ccf. Within 30 days after filing its tariff schedules San Gabriel shall file an advice letter to be approved by the Water Division setting forth the amount and method of the refund.
4. To amortize its Water Quality Litigation Memorandum Account San Gabriel shall file an advice letter setting forth a detailed description of the service provided. The amount approved by the Water Division shall be recovered by surcharge.
5. San Gabriel Valley Water Company shall continue to track the costs of the CARW program and annually report to the Director of the Water Division the costs of such a program. San Gabriel may seek to have the costs recovered via a surcharge rather than in rates by filing an advice letter.
6. San Gabriel Valley Water Company Fontana Division shall file an application with the Commission within 120 days after the effective date of this decision requesting approval for the implementation of the Water Action Plan objectives.
7. For violation of Pub. Util. Code § 2107 and our affiliate transaction rule, San Gabriel shall pay a fine to the State of $20,000.
8. For failure to report the violation of our affiliate transactions rule, San Gabriel shall pay a fine to the State of $20,000.
9. For violation of Rule 1 of our Rules of Practice and Procedure, San Gabriel shall pay a fine to the State of $20,000.
10. Application 05-08-021 and Investigation 06-03-001 shall remain open to resolve the issues related to the proceeds from condemnations, sales under threat of condemnations and from inverse condemnations once the broader policy determinations have been made in R.04-09-003.
This order is effective today.
Dated _____________, at San Francisco, California.
1 On October 2, 2006, San Gabriel mailed a letter to Commissioner Bohn informing him of a successful recycled water project. A copy of the letter has been placed in the correspondence file.
2 See Ex. 16, Exhibit A, analysis of cash flows.
3 See, Ex. 48, Attachment 3b; Ex. 6, Attachment A1-2, A1-7.
4 Because $2,618,291 of this gain has been invested in Plant F-10 and recorded as CIAC only an additional $1,674, 697.50 should be added to CIAC.
($8,377,423 ÷ 2) - $2,618,291 = $1,570,421.)
